The Board of Directors of Finley Corporation Is Considering Two

Essay

The board of directors of Finley Corporation is considering two plans for financing the purchase of new plant equipment. Plan #1 would require the issue of $4,000,000, 6%, 20-year bonds at face value. Plan #2 would require the issue of 200,000 common shares for $20 per share. Finley Corporation currently has 100,000 common shares issued at a book value of $20 each and retained earnings of $750,000. The income tax rate is expected to be 30%. Assume that income before interest and income taxes is expected to be $800,000 if the new factory equipment is purchased. Assume that the debt or equity will be issued at the beginning of the year.
Instructions
a. Prepare a schedule which shows the expected profit, earnings per share, and return on equity under each of the plans that the board of directors is considering.
b. If the board of directors' stated goal is to maximize the common shareholders' return, which alternative is preferable? If the board's stated goal is to maximize solvency, which alternative is preferable?