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Mc Kiah Berhad has the following capital structure: RM 300,000 of debt at 10 percent RM...

Mc Kiah Berhad has the following capital structure: RM 300,000 of debt at 10 percent RM 600,000 common stock with par value of RM10. The company is planning to raise additional RM300,000 to finance a new project next year. They are considering these two options of financing: Option A To issue bond for RM300,000 at a par value of RM1,000 and at coupon interest rate of 12 percent. Option B To issue new common stock at a price of RM20 per share. Corporate tax rate is 30 percent. Answer:

1. Calculate earnings before interest and taxes (EBIT) at the indifference level associated with both plans.

2. Calculate earnings per share (EPS) at the point of indifference.

Solutions

Expert Solution

(1)

Given

Particulars Current Plan Option A Option B
Bond 300000RM 300000 RM -
Interest 10% 12% -
Face Value 1000RM 1000RM -
Equity (A) 600000RM - 300000RM
Stock Price (B) 10 - 20
Number of shares (A/B) 60000 - 15000
Tax Rate (t) 30%

Indifference Point in EBIT formula

(EBIT-Interest in option 1)*(1-taxes)/Number of shares under option 1 =

(EBIT-Interest in option 2)*(1-taxes)/Number of shares under option 2

Interest Under Option 1 = Current plan interest + option 1 Interest = (3000000*10%) + (300000*12%) = 66,000$

Number of shares under option 1 = Current plan shares + option 1 Number of shares = 60000+0 = 60,000 shares

Interest Under Option 2 = Current plan interest + option 2 Interest = (3000000*10%) + 0 = 30,000$

Number of shares under option 2 = Current plan shares + option 2 Number of shares = 60000+15000 = 75,000 shares

(EBIT - 66000)*(1-0.30) / 60000 = (EBIT - 30000)*(1-0.30)/75000

(EBIT-66000)/(EBIT-30000) = (0.70/75000) * (60000/0.70)

EBIT - 66000 = 0.8*(EBIT-30000)

EBIT-66000 = 0.8EBIT - 24000

0.2 EBIT = 42000

EBIT = 210,000$

(2)

Particulars Option A Option B
EBIT 2,10,000 2,10,000
Less:Interest -66000 -30000
EBT 1,44,000 1,80,000
Less:Tax @ 30% -43200 -54000
PAT (A) 1,00,800 1,26,000
Number of share (B) 60000 75000
Earnings Per Share (A/B) 1.68 1.68

jeff jeffy answered 1 year ago
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