Question

The present capital structure of Ali Co. ltd. is: 4000, 5% Debentures of $ 100 each $ 4,00,000 2000, 8% P. Shares of $ 100 each $ 2,00,000 4000, Equity shares of $100 each $ 4,00,000 $ 10,00,000 The present earning of the company before interest & taxes are 10% of the invested capital every year. The company is in need of $ 2,00,000 for purchasing a new equipment and it is estimated that additional investment will also produce 10% earning before interest & taxes every year. The company has asked your advice as to whether the requisite amount be obtained in the form of 5% Debenture or 8% P. Shares Or equity shares of $ 100 each to be issued at par. Examine the problem in all its bearing and advice firm if the Corporate tax rate is 50%.

Answer 1

Answer: Earning per share (EPS) i.e $7.5 is highest in the option where the firm choose 5% Debentures as the source of additional investment.