The Howland Carpet Company has grown rapidly during the past 5 years. Recently, its commercial bank urged the company to consider increasing its permanent financing. Its bank loan under a line of credit has risen to $250,000, carrying an 8 percent interest rate. Howland has been 30 to 60 days late in paying trade creditors. Discussions with an investment banker have resulted in the decision to raise $500,000 at this time. Investment bankers have assured the firm that the following alternatives are feasible (flotation costs will be ignored):

• Alternative 1: Sell common stock at $8.
• Alternative 2: Sell convertible bonds at an 8 percent coupon convertible into 100 shares of common stock for each $1,000 bond (that is, the conversion price is $10 per share).
• Alternative 3: Sell debentures at an 8 percent coupon, each $1,000 bond carrying 100 warrants to buy common stock at $10. John L. Howland, the president, owns 80 percent of the common stock and wishes to maintain control of the company. One hundred thousand shares are outstanding. The following are extracts of Howland’s latest financial statements:

a. Show the new balance sheet under each alternative. For Alternatives 2 and 3, show the balance sheet after conversion of the bonds or exercise of the warrants. Assume that half of the funds raised will be used to pay off the bank loan and half to increase total assets.
b. Show Mr. Howland’s control position under each alternative, assuming that he does not purchase additional shares.
c. What is the effect on earnings per share of each alternative, if it is assumed that profits before interest and taxes will be 20 percent of total assets?
d. What will be the debt ratio under each alternative?
e. Which of the three alternatives would you recommend to Howland, and why?

To answer these questions, we need to analyze each alternative and calculate the impact on the balance sheet, Mr. Howland's control position, earnings per share (EPS), and the debt ratio. Let's go through each alternative one by one.

Alternative 1: Sell common stock at $8
In this alternative, Howland will sell common stock at a price of $8. Since the company wants to raise $500,000, we divide $500,000 by $8 to find that they need to sell 62,500 shares. This will dilute Mr. Howland's ownership percentage. Let's calculate the new balance sheet, Mr. Howland's control position, EPS, and debt ratio.

New balance sheet:
- Cash will increase by $500,000.
- Common stock will increase by $500,000 (62,500 shares at $8/share).
- Total assets will increase by $500,000.

Mr. Howland's control position:
- If Mr. Howland does not purchase any additional shares, his ownership percentage will decrease. To calculate the new ownership percentage, we divide Mr. Howland's current ownership (80,000 shares) by the new total shares outstanding (100,000 + 62,500 shares).

EPS:
- Profits before interest and taxes are assumed to be 20% of total assets.
- We calculate the total assets after the stock issuance ($500,000 increase) and multiply it by 20%.
- Divide this amount by the new total shares outstanding to get EPS.

Debt ratio:
- Divide the current bank loan balance ($250,000) by the total assets after the stock issuance.

Alternative 2: Sell convertible bonds at an 8% coupon
In this alternative, Howland will issue convertible bonds at an 8% coupon rate, with each bond convertible into 100 shares of common stock at a conversion price of $10 per share. Let's calculate the new balance sheet, Mr. Howland's control position, EPS, and debt ratio after the conversion of the bonds.

New balance sheet:
- Cash will increase by $500,000.
- Convertible bonds will increase by $500,000 (bond issuance).
- Total assets will increase by $500,000.

Conversion of bonds:
- Each bond is convertible into 100 shares of common stock.
- Multiply the number of convertible bonds issued (500) by 100 to get the number of new shares after conversion.
- Add this to the initial number of shares outstanding to find the new total shares outstanding.

Mr. Howland's control position:
- Divide Mr. Howland's current ownership (80,000 shares) by the new total shares outstanding.

EPS:
- Calculate the total assets after the bond issuance ($500,000 increase) and multiply by 20%.
- Divide this amount by the new total shares outstanding to get EPS.

Debt ratio:
- Divide the current bank loan balance ($250,000) by the total assets after the bond issuance.

Alternative 3: Sell debentures at an 8% coupon with warrants
In this alternative, Howland will issue debentures at an 8% coupon rate, with each $1,000 bond carrying 100 warrants to buy common stock at $10. Let's calculate the new balance sheet, Mr. Howland's control position, EPS, and debt ratio after the exercise of the warrants.

New balance sheet:
- Cash will increase by $500,000.
- Debentures will increase by $500,000 (bond issuance).
- Total assets will increase by $500,000.

Exercise of warrants:
- Each warrant allows the holder to buy 1 share of common stock at $10.
- Multiply the number of debentures issued (500) by 100 to get the number of warrants.
- Assuming all warrants are exercised, add this to the initial number of shares outstanding to find the new total shares outstanding.

Mr. Howland's control position:
- Divide Mr. Howland's current ownership (80,000 shares) by the new total shares outstanding.

EPS:
- Calculate the total assets after the debenture issuance ($500,000 increase) and multiply by 20%.
- Divide this amount by the new total shares outstanding to get EPS.

Debt ratio:
- Divide the current bank loan balance ($250,000) by the total assets after the debenture issuance.

Lastly, compare the results for each alternative and provide a recommendation to Howland based on the impact on Mr. Howland's control position, EPS, and debt ratio.