Watson Metal Products is planning to expand its operations to France in response to increased demand from the French for quality metal products to use in production processes. Ben Watson, president of Watson Metal Products, and his consultants have estimated that the expansion will require an investment of $5 million. They have also estimated that this expansion will cause net income before interest expense to increase by $1,500,000. The company is considering financing the expansion through one of the following alternatives.

Alternative 1: Issue 200,000 shares of common stock for $25 per share.

Alternative 2:Issue long-term debt at an annual interest cost of 15 percent. The principal would be payable in ten years.

Alternative 3:Issue 100,000 shares of common stock for $25 per share and finance the remainder by issuing long-term debt at an annual interest of 15 percent. The principal would be payable in ten years.

The income statement for the year ended December 31, 2012, of Watson Metal Products was as follows:

Sales                                        $150,000,000

Cost of goods sold                   (90,000,000)

Other expenses                         (45,000,000)

Income from operations          $ 15,000,000

Interest taxes                            4,000,000

Net income before taxes         $  11,000,000

Income taxes                            4,400,000

Net income                              $ 6,600,000

Earnings per share                   $           3.30

Prior to the expansion, the total debt of Watson Metal Products was $35 million, and total shareholders’ equity was $45 million. There were no changes in total debt and total shareholders’ equity other than those due to net income and the expansion project. Federal and state income tax rates total 40 percent.

REQUIRED:

a. Assume that the company’s net income from non-French operations in 2013 equals the income earned in 2012 and that the estimated income from operations on the expansion is realized in 2013. Compute earnings per share, return on equity, return on assets, common equity leverage, and the capital structure leverage as of December 31, 2013, if the company finances the expansion through the following:

(1) Alternative 1

(2) Alternative 2

(3) Alternative 3

Assume that the December 31, 2013, balances equal average balances during 2013.

b. Assume that you are currently a shareholder in Watson Metal Products. Which expansion alternative would you prefer? Explain your answer.

c. What amount of net income would Watson Metal Products have to generate from the expansion project so that earnings per share would be the same before and after the expansion under each alternative?