You are investigating the expansion of your business and have sought out two avenues for the sourcing of funds for the expansion. The first (Plan A) is an all-ordinary-share capital structure. $1 million would be raised by selling 200,000 shares at $5 each. Plan B would involve the use of financial leverage. $800,000 would be raised issuing bonds with an effective interest rate of 15% (per annum). Under this second plan, the remaining $200,000 would be raised by selling 40,000 shares at $5 price per share. The use of financial leverage is considered to be a permanent part of the firm's capitalisation, so no fixed maturity date is needed for the analysis. A 30% tax rate is appropriate for the analysis. REQUIRED: a) Find the EBIT indifference level associated with the two financing plans using an EBIT-EPS graph. Check your results algebraically. b) A detailed financial analysis of the firm's prospects suggests that the long-term earnings before interest and taxes (EBIT) will be $100,000 annually. Taking this into consideration, which plan will generate the higher earnings per share (EPS)? c) Briefly explain the primary weakness of EBIT-EPS analysis as a financing decision tool.
You are investigating the expansion of your business and have sought out two avenues for the sourcing of funds for the expansion. The first (Plan A) is an all-ordinary-share capital structure. $1 million would be raised by selling 200,000 shares at $5 each. Plan B would involve the use of financial leverage. $800,000 would be raised issuing bonds with an effective interest rate of 15% (per annum). Under this second plan, the remaining $200,000 would be raised by selling 40,000 shares at $5 price per share. The use of financial leverage is considered to be a permanent part of the firm's capitalisation, so no fixed maturity date is needed for the analysis. A 30% tax rate is appropriate for the analysis. REQUIRED: a) Find the EBIT indifference level associated with the two financing plans using an EBIT-EPS graph. Check your results algebraically. b) A detailed financial analysis of the firm's prospects suggests that the long-term earnings before interest and taxes (EBIT) will be $100,000 annually. Taking this into consideration, which plan will generate the higher earnings per share (EPS)? c) Briefly explain the primary weakness of EBIT-EPS analysis as a financing decision tool.
Chapter14: Capital Structure Management In Practice
Section: Chapter Questions
Problem 20P
Related questions
Question
100%
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 4 steps with 3 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Recommended textbooks for you
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:
9781337514835
Author:
MOYER
Publisher:
CENGAGE LEARNING - CONSIGNMENT
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:
9781337514835
Author:
MOYER
Publisher:
CENGAGE LEARNING - CONSIGNMENT