Southern Merchandising Inc. is considering new financing to pay out $ 2,500,000 of existing 10% bonds payable at the beginning of the next fiscal year. The company wants to maximize ROE in the new year. They are considering three alternatives of dealing with the matter:
1. Do not pay out the existing bonds;
2. Issue a 5% bond payable at face value of $ 2,500,000, or issue 250,000 common shares at $ 10.
Other information about Southern:
-Southern's tax rate is 25%.
-Southern currently has $ 4,000,000 in shareholders' equity prior to any new share issue.
-Southern's average profit before financing costs and taxes is $ 800,000.
-A one-time penalty of $ 150,000 will be incurred to pay out the 10% bonds early, which is fully tax deductible.
Instructions
Calculate the following amounts for Southern, compare all three alternatives, and make a recommendation, assuming the goal is to maximize return on equity for the next year.

Question

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The Answer of Southern Merchandising Inc. is considering new financing to pay out $ 2,500,000 of existing 10% bonds payable at the beginning of the next fiscal year. The company wants to maximize ROE in the new year. They are considering three alternatives of dealing with the matter:
1. Do not pay out the existing bonds;
2. Issue a 5% bond payable at face value of $ 2,500,000, or issue 250,000 common shares at $ 10.
Other information about Southern:
-Southern's tax rate is 25%.
-Southern currently has $ 4,000,000 in shareholders' equity prior to any new share issue.
-Southern's average profit before financing costs and taxes is $ 800,000.
-A one-time penalty of $ 150,000 will be incurred to pay out the 10% bonds early, which is fully tax deductible.
Instructions
Calculate the following amounts for Southern, compare all three alternatives, and make a recommendation, assuming the goal is to maximize return on equity for the next year.