Assignment - Exploring Financing options: Debt versus Equity John Brown owns a business and wants to expand

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Assignment - Exploring Financing options: Debt versus Equity

John Brown owns a business and wants to expand. He can either borrow money or sell additional equity. Currently he is the sole owner of the business. Complete the information below for two different scenarios: In Scenario A, John's company borrows an additional $200,000 and in Scenario B, the company sells (company raises money) an additional $200,000 in common stock at $1 per share. Complete the columns below for Scenarios A & B. Which option would you advise John to take (more debt or sell equity) and why? Assume that revenues and expenses (other than those related to debt) do not change. (Money raised from either debt or equity will be reinvested in the business, but you do not have to show the increase in other assets or any potential increase in revenues).

Abbreviated Balance Sheet Information

Currently

Scenario A

More Debt

Scenario B

More Equity

Liabilities

Debt

$75,000

Stockholder's Equity

Common Stock (currently 200,000 shares/ $1 each)

$200,000

Retained Earnings

$ 50,000

Total Equity

$250,000

Abbreviated Income Statement

Revenues

$125,000

Expenses (not including interest and taxes)

60,000

Inc. before interest and taxes

65,000

Interest expense (at 3% on debt amt. above)

2,250

PreTax Income

62,750

Taxes (rate of 25%)

15,687.50

Net Income

$ 47,062.50

ROE

.188

Debt to Equity Ratio

.30