Dickinson Company has $12,060,000 million in assets. Currently half of these assets are financed with long-term debt at 10.3 percent and half with common stock having a par value of $8. Ms. Smith, Vice President of Finance, wishes to analyze two refinancing plans, one with more debt (D) and one with more equity (E). The company earns a return on assets before interest and taxes of 10.3 percent. The tax rate is 40 percent. Tax loss carryover provisions apply, so negative tax amounts are permissable.
Under Plan D, a $3,015,000 million long-term bond would be sold at an interest rate of 12.3 percent and 376,875 shares of stock would be purchased in the market at $8 per share and retired.
Under Plan E, 376,875 shares of stock would be sold at $8 per share and the $3,015,000 in proceeds would be used to reduce long-term debt.