FNCE 3001 Week 9 Debt or Equity Financing Note Example

Funding Three New Stores at Juniper Peak Sports: Borrowing $6 Million or Issuing 400,000 Shares, Worked Through on the Company's Own Balance Sheet, Coverage and Earnings per Share

Student Name

Walden University

FNCE 3001: Financial Management

Instructor Name

Month Day, Year

Funding Three New Stores at Juniper Peak Sports: Borrowing $6 Million or Issuing 400,000 Shares, Worked Through on the Company's Own Balance Sheet, Coverage and Earnings per Share

The Need

Juniper Peak Sports, a composite retailer with fourteen stores in two states, plans to open three stores in Boise, Idaho, and Fort Collins and Grand Junction, Colorado, over the next year. Fit-out, fixtures and opening inventory will cost $6.0 million. Management expects the three stores to add about $1.2 million a year to operating income once open. This note compares two ways of raising the $6.0 million: a 7.5 percent term loan repaid over seven years, or a sale of 400,000 new shares at $15 each. Figures are in thousands unless marked otherwise.

The Company as It Stands

At the end of fiscal 2025 Juniper Peak had total debt of $12,000 thousand, all on its existing term loan, of which $1,500 thousand falls due within the year; the notes show the loan amortizing in equal annual payments through fiscal 2032. Interest expense for the year was $900 thousand. Shareholders' equity was $23,800 thousand, and 4,000,000 shares were outstanding. Operating income was $7,140 thousand. On these figures debt to equity is 0.50, times interest earned is 7.9 and earnings per share were $1.17.

The Two Options Worked Through

Both cases assume operating income rises to $8,340 thousand with the new stores ($7,140 plus $1,200) and a 25 percent tax rate. To isolate the financing choice, the existing loan is held at its current balance.

Table 1

The Two Financing Options Compared (in thousands, except per-share figures)

Composite company. Borrowing adds $450 thousand of interest at 7.5 percent. Equity in the share-issue case rises by $6,000 thousand.

Borrowing

Borrowing adds $450 thousand a year in interest. Net income rises to $5,243 thousand, and because no new shares are issued, earnings per share rise to $1.31, a 12 percent increase. The cost is in the balance sheet. Debt to equity rises from 0.50 to 0.76, and times interest earned falls from 7.9 to 6.2. The company would still cover its interest more than six times, but the new loan's payments, about $1.1 million a year including principal, would sit alongside the existing $1.5 million of annual principal repayments.

Issuing Shares

Issuing 400,000 shares raises $6.0 million with no new interest. Net income rises more, to $5,580 thousand, but it is spread over 4.4 million shares, so earnings per share are $1.27. Existing shareholders' claim on earnings is diluted by 9.1 percent (400,000 / 4,400,000). Debt to equity falls to 0.40, and times interest earned rises to 9.3. The balance sheet becomes stronger, and the company keeps its full borrowing capacity for later. There is a pricing cost as well: at $15, the new shares sell for about 12.8 times fiscal 2025 earnings per share. If the new stores succeed and the market later values the company more highly, today's owners will have given part of that gain to the new investors.

The Break-Even Point Between the Two

The two options give the same earnings per share at the operating income where (EBIT − 1,350) x 0.75 / 4,000 = (EBIT − 900) x 0.75 / 4,400. Solving gives EBIT of $5,850 thousand. Above that level, borrowing produces higher earnings per share; below it, issuing shares does. Projected operating income of $8,340 thousand is well above the break-even point, so borrowing wins on earnings per share unless operating income fell by about 30 percent (Brigham & Houston, 2022).

Comparison and Recommendation

Borrowing gives higher earnings per share and keeps ownership with the current shareholders. Issuing shares gives a stronger balance sheet and leaves room to borrow later. Modigliani and Miller (1958) showed that, without taxes and other frictions, the choice would not change the firm's value; in practice, the tax deduction for interest tilts the balance toward debt, while the risk of financial distress favors equity (Ross et al., 2022). For Juniper Peak, the inventory build of fiscal 2025 and a business tied to snow both argue for caution. The recommendation is to borrow, but to borrow $4.0 million rather than $6.0 million and fund the remaining $2.0 million from the cash released by clearing excess winter inventory. That keeps debt to equity near 0.67 and times interest earned near 7.0, both close to fiscal 2024 levels, and because less interest is paid, earnings per share would come to about $1.34.

References

Brigham, E. F., & Houston, J. F. (2022). Fundamentals of financial management (16th ed.). Cengage Learning.

Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment. The American Economic Review, 48(3), 261-297.

Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2022). Fundamentals of corporate finance (13th ed.). McGraw Hill.