Telford Engineers Limited, a medium-sized manufacturer of automobile components, has decided to modernize its factory by incorporating a number of robots. These will cost $20 million and will reduce operating costs by $6 million a year for their estimated useful life of 10 years starting next year (Year 10). To finance this plan the business can raise $20 million by either:
issuing 20 million common shares at $1 each, or issuing long-term bonds at 14% interest a year, with capital repayments of $3 million a year commencing at the end of Year 11.

Assumptions for Year 10: the corporate tax rate is 30%;

▪ sales revenue and operating profit will remain unchanged except for the $6 million cost savings, and 

▪ Telford Engineers will pay the same dividend per share in Year 10 and in Year 9.
Prepare, for each financing arrangement, Telford Engineers' pro forma income statement including the addition to retained earnings for the year ending December 31, Year 10, and the pro forma long-term debt and shareholders' equity portion of the balance sheet only on that date.

Year 6 Year 7 Year 8 Year 9 Year10
Current assets 55 67 57 55
Non-current assets 48 51 65 64
Total assets 103 118 122 119

Current liabilities
Bank overdraft 5 0 6 8
Accounts payable 20 27 25 18
Total current liabilities 25 27 31 26
Long-term liabilities 30 30 30 30
Total liabilities 55 57 61 56

Shareholders' equity
Common shares 20 20 20 20
Retained earnings 28 41 41 43
Shareholders' equity 48 61 61 63

Total liabilities and shareholders' equity 103 118 122 119

Other information:
Number of shares issued 80 80 80 80
Market share price $1.50 $2.00 $1.00 $1.45

Summary Income Statements
Including Addition to Retained Earnings
For the years ended December 31
($ millions)

Year 6 Year 7 Year 8 Year 9
Sales 152 170 110 145
EBIT 28 40 7 15
Interest expense 4 3 4 5
Earnings before taxes 24 37 3 10
Tax expense 12 16 0 4
Net income 12 21 3 6
Less: Dividends paid 6 8 3 4
In addition to retained earnings 6 13 0 2

Issuing Long-Term Bonds Option:

Summary of the Balance Sheet
As of December 31 Pro Forma
($ millions)
Year 6 Year 7 Year 8 Year 9 Year 10
Current assets 55 67 57 55
Non-current assets 48 51 65 64
Total assets 103 118 122 119

Current liabilities
Bank overdraft 5 0 6 8
Accounts payable 20 27 25 18
Total current liabilities 25 27 31 26
Long-term liabilities 30 30 30 30 0
Total liabilities 55 57 61 56 Total long-term liabilities 0

Shareholders' equity
Common shares 20 20 20 20
Retained earnings 28 41 41 43
Shareholders' equity 48 61 61 63 0

Total liabilities and shareholders' equity 103 118 122 119 Long-term debt and shareholders' equity 0

Other information:
Number of shares issued 80 80 80 80
Market share price $1.50 $2.00 $1.00 $1.45

Summary Income Statements
Including Addition to Retained Earnings
For the years ended December 31 Pro Forma
($ millions)

Year 6 Year 7 Year 8 Year 9 Year 10
Sales 152 170 110 145
EBIT 28 40 7 15
Interest expense 4 3 4 5
Earnings before taxes 24 37 3 10 0
Tax expense 12 16 0 4
Net income 12 21 3 6 0
Less: Dividends paid 6 8 3 4
Addition to retained earnings 6 13 0 2 0

Question:

Smil Business finance Equity vs. Debt?

Answer rating: 100% (QA)

Telford Engineers Limited Pro forma income state... View the full answer