Question 4 (30 marks-45 minutes) EPS Pty (Ltd) is a manufacturing company that h

Question

Question 4 (30 marks-45 minutes) EPS Pty (Ltd) is a manufacturing company that has been listed on the JSE for the last 15 years. Approximately 35 percent of its sales are to government and 65 percent to private customers. The company has been growing erratically in recent years, but in real terms at a rate on average equal to that of the economy as a whole. Recent analyst's reports suggest that the firm's rate of growth might increase significantly in the near to mid future because of the government's accelerated infrastructure investment program. However, EPS' management believes that the analysts are overoptimistic in this regard and are worried 9 about the effects of increased inflationary pressures. The company's shares, which are 0largely institutionally held, are currently selling at 14 times earnings. The industry average PE ratio is 12, The company's Return on Equity (ROE) was 17% pa. compared to the industry 12 | average of 23%. The company's most recent total dividend payout was R5m which 13 represented a dividend cover of 2.5 times (the industry average is 2 times). The company has 4 assets of R200 million and a debt to capital ratio of 20 percent (the industry average is 22 15 percent). 7EPS is budgeting for growth in the next 12m and needs an additional R25 million in capital 8 over and above additions to retained earnings to support its projected level of business 19 20 activties a. Identify the stage of this company's lifecycle and identify the normal sources of funding for such a stage. (3 marks) (3 marks) (2 marks) b. Calculate the company's current Debt/Equity (D/E) ratio. 4 What would it the new D/E ratio be if it raises debt to finance its growth? 6 c. Discuss the pros and cons of the following sources of finance for EPS 1. New long term debt 2. New short term debt 3. Equity capital 4. Convertible debt 9 30 4 marks each 16 marks) 83 d. What would you recommend that EPS should do? 34 (6 marks)

Explanation / Answer

a. The Company is at Growth Stage of it's lifecycle .At this stage company needs significant amount of capital.It requires funds to launch a newly focused marketing campaign as well as funds for continued investment in property, plant, and equipment. As companies expects sales growth, business risks decrease, while their ability to raise debt increases.Entrepreneurs typically seek larger higher funding from Angels groups and Venture Captalists.

Angel Investors are they who provide investment and Intellectual Capital to the business.These resources are provided in exchange for Covertible Debt and/or Equity Capital.

Venture Capitalists are a type of Private Equity Capital Investors.They Invest their money to support the business in growth.

b. Current Debt/Equity Ratio :

C.If the company raises Debt Capital to fund for it's growth,The D/E Ratio would become like :

C.1.New Long Term Debt

Advantages

Disadvantages

2. New Short Term Debt

Advantages

Disadvantages

3.Equity Capital

Advantages

Disadvantages

4.Covertible Debt

Advantages

Disadvantages

d. I would recommend the company to go with the Debt Financing.D/E ratio will remain standard and the company would get the benifits i.e.

Dividend Coverage Ratio = 2.5 Dividend Payout was = R 50,00,000 So ,Net Income Available to Equity Shareholders is = 12500000 We know ROE = 17% So, Equity Capital = 73529412 We have the Debt-Capital Ratio = 0.2 So,Amount of Debt Capital (Equity Capital/80*20) 18382353 So,the Current D/E Ratio is = 0.25

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