Wireless Video Ltd. needs to expand operations for 2011 and is considering two financing options to raise $200 million-either issuing additional common shares or additional long-term bonds. The interest rate on the new bonds would be 10%. The new shares would require an additional annual dividend of $20 million. The most recent financial information is given below. EBIT is expected to grow by 10% in 2011.
2010
EBIT ...................................................$ 92,000
Interest .................................................$ 37,000
Dividends ..............................................$ 25,000
Corporate tax rate ..................................... 30%
Number of shares outstanding ......................100,000
Share price ............................................. $ 1,000
($000)
Current assets .......................................... 75,000
Property, plant, and equipment ......................700,000
Total assets .............................................775,000
Current liabilities ...................................... 40,000
Long-term bonds ......................................200,000
Total liabilities .........................................240,000
Common shares ........................................200,000
Retained earnings ......................................335,000
Total shareholders' equity .............................535,000
Total shareholders' equity and liabilities ...........775,000
Required:
(a) Prepare a pro forma income statement including additions to retained earnings for 2011 for each financing option.
(b) Prepare the long-term financing (bonds and equity) portion of the pro forma balance sheet for 2011.
(c) Calculate the ROE, earnings per share, times interest earned ratio, and the leverage ratio for each financing option.
(d) Which financing option would you recommend?