The Cox Computer Company has grown rapidly during the past five years. Recently its commercial bank urged the company to consider increasing its permanent financing. Its bank loan under a line of credit has risen to $150,000, carrying a 10 percent interest rate, and Cox has been 30 to 60 days late in paying trade creditors. Discussions with an investment banker have resulted in the decision to raise $250,000 at this time. Investment bankers have assured Cox that the following alternatives are feasible (flotation costs will be ignored):

Alternative 1: Sell common stock at $10 per share.
Alternative 2: Sell convertible bonds at a 10 percent coupon, convertible into 80 shares of common stock for each $1,000 bond (that is, the conversion price is $12.50 per share).
Alternative 3: Sell debentures with a 10 percent coupon; each $1,000 bond will have 80 warrants to buy one share of common stock at $12.50.

Charles Cox, the president, owns 80 percent of Cox€™s common stock and wishes to maintain control of the company; 50,000 shares are outstanding. The following are summaries of Cox€™s latest financial statements:

Income Statement
Sales.................................................... $550,000
All costs except interest.................... (495,000)
EBIT...................................................... $ 55,000
Interest................................................. ( 15,000)
EBT....................................................... $ 40,000
Taxes at 40%........................................ ( 16,000)
Net income.......................................... $ 24,000
Shares outstanding............................... 50,000
Earnings per share.................................. $0.48
Price/earnings ratio...................................... 18×
Market price of stock............................... $8.64

a. Show the new balance sheet under each alternative. For Alternatives 2 and 3, show the balance sheet after conversion of the debentures or exercise of the warrants. Assume that $150,000 of the funds raised will be used to pay off the bank loan and the rest to increase total assets.
b. Show Charles Cox€™s control position under each alternative, assuming that he does not purchase additional shares.
c. What is the effect on earnings per share of each alternative if it is assumed that earnings before interest and taxes will be 20 percent of total assets?
d. What will be the debt ratio under each alternative?
e. Which of the three alternatives would you recommend to Charles Cox and why?

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Balance Sheet Current liabilities Common stock, $1 par Retained eamings Total liabilities and equity $200,000 25,000 Total assets $275.000 $275.000