Carr Industries Must Raise $100 Million on January 1, 2012

Essay

Carr Industries must raise $100 million on January 1, 2012 to finance its expansion into a new market. The company will use the money to finance construction of four retail outlets and a distribution center. The stores are expected to open later this year. The CFO has come up with three alternatives for raising the money:
1) Issue $100 million of 8% nonconvertible debt due in 20 years.
2) Issue $100 million of 6% nonconvertible preferred stock (100,00 shares).
3) Issue $100 million of common stock (1 million shares).
The company's internal forecasts indicate the following 2012 year-end amounts before any option is chosen:
$$\begin{array} { | l | l | } \hline \text { in millions } & \\\hline \text { Tatil debt } & \$ 425 \\\hline \text { Tatel sharehrlders' equity } & 250 \\\hline \text { Net income forr the year } & 10 \\\hline & \\\hline\end{array}$$ Carr has no preferred stock outstanding but currently has 10 million shares of common stock outstanding. EPS has been declining for the past several years. Earnings in 2011 were $1 per share, which was down from $1.10 during 2010, and management wants to avoid another decline during 2012. One of the company's existing loan agreements requires a debt-to-equity ratio to be less than 2. Carr pays taxes at a 40% rate.
Required:
1. Assess the impact of each financing alternative on 2012 EPS and the year-end debt to equity ratio.
2. Which financing alternative would you recommend and why?