Unit 4- Assessment A

Assume that Kelly Giard of Clean Air Lawn Care decides to launch a new retail chain to market electrical mowers. This chain, named Mow Green, requires $500,000 of start-up capital. Kelly contributes $375,000 of personal assets in return for 15,000 shares of common stock, but he must raise another $125,000 in cash. There are two alternative plans for raising the additional cash:
Plan A is to sell 3,750 shares of common stock to one or more investors for $125,000 cash.
Plan B is to sell 1,250 shares of cumulative preferred stock to one or more investors for $125,000 cash (this preferred stock would have a $100 par value, an annual 8% dividend rate, and be issued at par). Required: |
If the new business is expected to earn $72,000 of after-tax net income in the first year, what rate of return on beginning equity will Kelly earn under each alternative plan? Which plan will provide the higher expected return?
To: Kelly Giard
From: Nicole Meza
Kelly, if you use Plan A, you will get a 14.4% rate of return. 72,000 /500,000 = 14.4% If you used Plan B, you will get a 16.5% rate of return
Net (after-tax) income- $72,000
Less preferred dividends 8%- 10,000
Balance to common stockholders- 62, 000
Return to common stockholders- (62,000/375,000) =16.5%
Using Plan B, will provide you a higher expected