Question: The Manufacturing Company is planning an expansion program that requires new capital of $32,000,000. The firm currently has 1 2,000,000 shares outstanding and $25,000,000 in longterm debt at an interest rate of 10 percent. Earnings before interest and taxes for the year just ended were $ 1 4,500,000. With the new financing, they are expected to increase to $18,000,000 for the current year, and to grow at a rate of 8 percent annually thereafter for the indefinite future. The firm's shares have generally traded at a price-earnings ratio of 1 5, and it is expected that they will continue to do so. The corporate tax rate is 40 percent.

(a) Compute the current market price of the firm's shares.

(b) Assume that new shares could be issued to net the company 10 percent less than the current market price. If the new capital were raised through an issue of common shares, how many new shares would have to be issued? Compute earnings per share and the market price per share at the end of the current year (year 1) and at the end of year 3.

(c) Alternatively, the new capital could be raised by issuing 20-year convertible debentures with a face value of $ 1,000 each, at an interest rate of 11 percent. The conversion price would be set at 20 percent above the current market price of the shares. A call feature would allow the corporation to redeem the issue at any time after year 3 at a premium of 3 percent over face value. Current interest rates on otherwise comparable straight debt are 12.5 percent.

(i) Assuming that the projections materialize and that interest rates remain unchanged, compute the straight-debt value and the conversion value at the end of year 3. Can the corporation force conversion at that time?

(ii) Assuming that conversion has taken place, compute earnings per share and market price per share at the end of year 3.

(d) Based on the information given, what method for raising the funds appears preferable? What are the risks and trade-offs?