Mountainside Medical Goods is embarking on a massive expansion. Assume plans call for opening 20 new stores during the next two years. Each store is scheduled to be 30% larger than the company's existing locations, offering more items of inventory and with more elaborate displays. Management estimates that company operations will provide $1 million of the cash needed for expansion. Mountainside Medical must raise the remaining $4.5 million from outsiders.
The board of directors is considering obtaining the $4.5 million either through borrowing at 9% or by issuing an additional 500,000 shares of common stock. This year the company has earned $2.5 million before interest and taxes and has 500,000 shares of $1-par common stock outstanding. The market price of the company's stock is $9.00 per share. Assume that income before interest and taxes is expected to grow by 30% each year for the next two years. The company's marginal income tax rate is 20%.
Requirements
1. Use Excel to evaluate the effect of the above projected alternatives on net income and earnings per share two years from now.
2. Write a memo to Mountainside's management discussing the advantages and disadvantages of borrowing and of issuing common stock to raise the needed cash. Which method of raising the funds would you recommend?