Retail Fun Inc. is embarking on a massive expansion with plans to open 10 new stores during the next two years. Each store will be will offer more technology and space compared to the companys existing locations. The estimated cost of the expansion is $6 million. Internally generated operating cash flow will provide $1 million of the cash needed for expansion. Retail Fun must raise the remaining $5 million by borrowing or selling shares.

Two financing alternatives are being considered:

Borrow at 3% p.a.

Issue an additional 100,000 shares of common shares at an expected market price of $50 per share

Other Information:

Retail Fun Inc. currently has no interest-bearing debt

this year the company earned $2.5 million before interest and taxes earnings before interest and taxes (EBIT) is expected to grow by 10% each year for the next two years

ie, EBIT in two years is expected to be 2.5 x 1.10² = $3.025 million

100,000 shares of $1-par common stock outstanding

the companys income tax rate = 20%

The managers at Retail Fun Inc. have asked you to:

Evaluate the effect of the above projected alternatives on net income and earnings per share two years from now

Prepare a brief report on the pros and cons of each alternative, and

Make a recommendation on whether to borrow or sell shares; briefly explain your recommendation.