Reference no: EM132783411

Question - Pipsqueak Co. has an exciting opportunity to buy out its main local competitor for $200,000. Doug Kindle, owner/operator of the business, calculates the combined EBIT of the merged companies would be $350,000. To pay for the acquisition, he is considering taking out a loan with his local bank, backed by his home mortgage, at an interest rate of 8%. In addition, $7500 of principal payments would be due each year. Fortunately, the company only has a small amount of existing debt, necessitating $10,000 in annual interest payments and $3000 in principal payments. However, the owner of Pipsquek's competitor has offered to instead take stock as a form of payment, rather than cash. In this case, Doug would issue shares of stock at $10 per share, and the competitor's current owner would become a part-owner in Pipsqueak Co. Doug's accountant tells him his current stock is worth about $15 per share.

Doug owns all 80,000 existing shares. The company's tax rate is 21%.

Required -

a) If the company raises the funding with equity, what will be its times-interested earned ratio? What will be its times-burden-covered ratio? What will be its earnings per share?

b) If the company raises the funding with debt, what will be its times-interested earned ratio? What will be its times-burden-covered ratio? What will be its earnings per share?

c) Which option would you suggest Doug pursue? Why?