Question

20X1 AND 20X2 FINANCIAL STATEMENTS Bio-Fuels Generation Incorporated Statement of comprehensive income for the year ended December 31 20X2 $ 20X1 $ Revenue Cost of goods sold Gross profit 10,458,240 9,075,000 1,383,240 9,734,502 8,473,800 1,260,702 Expenses Selling and marketing Research and development General and administrative Other operating costs 103,500 370,020 458,200 15,900 947,620 92,400 365,100 423,900 14,200 895,600 Operating income Interest expense — line of credit Interest expense - long-term debt Earnings before taxes Income taxes Net income 435,620 (8,650) (149,270) 277,700 (69,425) 208,275 365,102 (7,150) (149,270) 208,682 (52,171) 156,511

Answer 1

The Company has two options to raise capital i.e. through preferred shares or through a loan. Both the options will affect cost of funds and cash flows of the Company. Lets try to analyze pros and cons under both options-:

a) Preferred Shares-: Preferred Shares if convertible to ordinary shares will be treated as the part of equity. This will dilute the current holding of the shareholders and control will be divided. The payment of dividend for preferred shares for convertible preferred shares generally carries low rate of fixed dividend and are generally participative in nature. And hence net earnings of ordinary shareholders will be decreased to the extent of dividend paid to them but not so much. There will be no redemption in cash and ordinary shares will be allotted to them on maturity date since the nature is convertible shares. Preferred shares if not convertible are in the nature of debt and will have fixed rate of dividend (generally similar to loan rate of interest). Upon maturity cash will be paid to discharge the amount by making bullet repayment.

b) Loan-: The complication for loan is to follow the debt covenants. The loan will have a fixed/floating interest expenses and thus will decrease the net earnings of the Company. The Company will be under pressure to maintain a healthy debt equity ratio. Upon maturity cash will be paid to discharge the loan. This may be discharged in terms of bullet repayment or equal installments over the tenure of loan. Further loans are generally secured and the Company has create a charge on the assets.

On the basis of above analysis, Company may decide the choice of fund.