A company has a capital of $ 1 billion consists of ordinary shares of 80,000 sha

Question

A company has a capital of $ 1 billion consists of ordinary shares of 80,000 shares each for $ 10,000 and debt of $200 and interest of 4% pa. the company needs an additional fund of $ 200 million that will be fulfill by: Alternative 1 : Issuance of new common shares Alternative 2 : Adding debt, interest 6% p.a. Then: 1. Calculate BREAK EVEN EBIT Assuming tax is 25%). 2. Prove the above calculation. 3. Draw the graph. 4. If the company's EBIT is $ 70 million, then which alternative is best? Why? A company has a capital of $ 1 billion consists of ordinary shares of 80,000 shares each for $ 10,000 and debt of $200 and interest of 4% pa. the company needs an additional fund of $ 200 million that will be fulfill by: Alternative 1 : Issuance of new common shares Alternative 2 : Adding debt, interest 6% p.a. Then: 1. Calculate BREAK EVEN EBIT Assuming tax is 25%). 2. Prove the above calculation. 3. Draw the graph. 4. If the company's EBIT is $ 70 million, then which alternative is best? Why? Alternative 1 : Issuance of new common shares Alternative 2 : Adding debt, interest 6% p.a. Then: 1. Calculate BREAK EVEN EBIT Assuming tax is 25%). 2. Prove the above calculation. 3. Draw the graph. 4. If the company's EBIT is $ 70 million, then which alternative is best? Why?

Explanation / Answer

Answer 1.. Plan I - All Equity and Plan II - All Debt -4% - Break Even Levels of EBIT EBIT - Plan I = EBIT - All Equity EPS - Plan I = EPS - All Equity [75% X (EBIT - $8)] / 100,000 = [75% X (EBIT - $16)] / 80,000 60,000 EBIT - $480,000 = 75,000 EBIT - $1,200,000 15,000 EBIT = 720,000 EBIT = 48 Millions Answer 2. Plan 1 Plan 2 EBIT          48,000,000          48,000,000 Less: Interest            8,000,000          16,000,000 EBT          40,000,000          32,000,000 Less: Tax - 25%          10,000,000            8,000,000 EAT          30,000,000          24,000,000 No. of Shares                100,000                  80,000 EPS                        300                        300 Answer 4. ` Plan 1 Plan 2 EBIT          70,000,000          70,000,000 Less: Interest            8,000,000          16,000,000 EBT          62,000,000          54,000,000 Less: Tax - 25%          15,500,000          13,500,000 EAT          46,500,000          40,500,000 No. of Shares                100,000                  80,000 EPS                        465                        506 Plan 2 is better, as EPS is higher than Plan 1

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