In: Accounting
The following three companies have asset financing structures which are considered to be aggressive, average and defensive strategists:
Statement of Financial Position as at 31st December, 2019 |
|||
Aggressive Ltd |
Average Ltd |
Defensive Ltd |
|
GHȼ000 |
GHȼ 000 |
GHȼ 000 |
|
Noncurrent assets |
175,000 |
125,000 |
100,000 |
Current assets |
75,000 |
125,000 |
150,000 |
Total assets |
250,000 |
250,000 |
250,000 |
Equity(100,000,000 @ Gh1) |
50,000 |
50,000 |
50,000 |
25% Debenture |
50,000 |
75,000 |
150,000 |
Current liabilities (average cost 3% pa) |
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Bank overdraft |
150,000 |
125,000 |
50,000 |
Total equity and liabilities |
250,000 |
250,000 |
250,000 |
Notes:
Required
Calculate the EPS for the three working capital financing strategists for the year ended December 31, 2019.
Characteristics of Working capital strategy:
Aggresive Strategy:
1. There is a high risk of bankruptcy due to extremely tight liquidity position being maintained.
2. Since the interest cost is minimized in this approach, higher profitability is obtained.
3. Liquidity is low due to greater dependability on short-term funds even for a part of long-term assets. It does not keep idle funds and therefore saves interest cost on them.
Moderate/Defensive Strategy:
1. There is a very low risk of bankruptcy as a higher level of liquidity is maintained in the business in this approach.
2. Under normal circumstances, profitability is less in this strategy because of too much idle and costly funds. Higher rate and bigger magnitude of interest cost reduce the profitability.
3. Liquidity is high, because of heavy usage of long-term funds. It can take advantage of sudden opportunities.
Average Strategy:
1. The risk is balanced here. The firm will bow down to bankruptcy only in an extremely bad situation.
2. Because of cut to cut management, a balance is achieved between interest cost and loss of profitability. Moderate profitability is maintained here. It is greater than conservative and lesser than aggressive.
3. Liquidity is balanced i.e. neither high nor low. It attempts to strike a balance between liquidity and cost of idle funds.
Calculation of EPS:
Particulars | Aggressive Ltd | Average Ltd | Defensive Ltd |
Net Profit before Interest and Tax (EBIT) | 80,000,000.00 | 80,000,000.00 | 80,000,000.00 |
Less: Bank Interest @ 15% | 22,500,000.00 | 18,750,000.00 | 7,500,000.00 |
Less: Interest on Debentures @ 25% | 12,500,000.00 | 18,750,000.00 | 37,500,000.00 |
Earning Before Taxes | 45,000,000.00 | 42,500,000.00 | 35,000,000.00 |
Less: Tax @ 25% | 11,250,000.00 | 10,625,000.00 | 8,750,000.00 |
Net Earning available for shareholders | 33,750,000.00 | 31,875,000.00 | 26,250,000.00 |
Equity Shares | 100,000,000.00 | 100,000,000.00 | 100,000,000.00 |
Earning Per share | 0.34 | 0.32 | 0.26 |
For understading:
You can see EPS in Aggresive method is higher than Defensive method. and EPS in Average method is balanced.