Quote:
Originally Posted by ayesha78
DP Company presently has Rs.3 million in debt outstanding bearing an interest rate of 12
percent. It wishes to finance a Rs.4 million expansion program and is considering three
alternatives: additional debt at 14 percent interest, preferred stock with a 12 percent dividend,
and the sale of common stock at Rs.16 per share. The company presently has 800,000 shares of
common stock outstanding and is in a 40 percent tax bracket.
(i) If earnings before interest and taxes are presently Rs.1.5 million, what would be
earnings per share for the three alternatives, assuming no immediate increase in
profitability?
(ii) Develop a break-even, or indifference chart for these alternatives. What are the
approximate indifference points? To check one of these points, what is the
indifference point mathematically between debt and common?
(iii) Which alternative do you prefer? How much would EBIT need to increase before the
next alternative would be best?
Kindly solve this question.
|
Solution:
i)
Debt preferred stock commn stock
EBIT Rs. 1500,000 1500,000 1500,000
interest on existing debt 360,000 360,000 360,000
int. on new debt 560,000 ------ -----
-----------------------------------------------
Profit before tax 580,000 1,140,000 1,140,000
taxes 232,000 456,000 456,000
-----------------------------------------------
profit after tax 348,000 684,000 684,000
pref. st. dividend ------- 480,000 -- --
------------------------------------------------
Earnings available 348,000 204,000 684,000
no. of shares 800,000 800,000 1050,000
-------------------------------------------------
Earning per share Rs. 0.435 0.255 0.65
Additional calculation:
interest (12% * 3000,000)
int. on new debt ( 14% * 4000,000)
No. of shares in common stock = sale of com. stock at 16/share (4000,000/16= 250,000) plus 800,000------1,050,000.
-------------------------------------------------