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The Management of “TanjungUdaBerhad” is planning a RM4,000,000 expansion this year. The expansion can be financed by issuing either common shares of bonds. The new common share can be sold for RM$5 per share. The bonds can be issued with a 12% coupon rates. The firm’s existing preference share pay dividends of RM$2 per share. The company’s corporate income tax is 30%. The financial statement of TanjungUdaBerhad is as follow:-
TanjungUdaBerhad
Balance Sheet as at 31st December 2021

Current Assets RM$ 2,000,000
Fixed Assets RM$ 8,000,000
RM$ 10,000,000

Current Liabilities RM$ 1,500,000
Bonds:
(8.5%, RM1,000 par value) RM$ 4,000,000
(9%, RM1,000 par Value) RM$ 1,000,000

Preference Shares
(RM$ 100 par value) RM$ 500,000

Ordinary Shares
(RM$ 2 par value) RM$ 2,400,000
Retained Earnings RM$ 600,000
RM$ 10,000,000
Required:
a) Calculate the indifference level of EBIT between the two Plans.
b) If EBIT is Expected to be RM1,500,000 which plan will result in ahigh EPS?

Respuesta :

Parrain

Based on the preference shares and the bond values given, the indifference level of EBIT for TanjungUdaBerhad is $1,142,857.

With an EBIT of RM1,500,000, the plan with the higher EPS will be to Issue bonds.

What is the indifference level of EBIT?

This can be found as:

(Indiffernce level x ( 1 - tax rate) - Preference share dividends) / Outstanding shares if new shares are issued = ( (Indifference level - Interest) x (1 - tax rate) - Preference dividends) / Outstanding shares if bonds issued

Outstanding shares if new shares are issued is:

= Current shares + New shares

= (2,400,000 / 2) + (4,000,000 / 5)

= 2,000,000 shares

Interest amount:

= 12% x 4,000,000

= $480,000

Indifference level is:

(I x ( 1 - 30%) - 10,000) / 2,000,000 = ( ( I - 480,000) x ( 1 - 30%) ) / 1,200,000

I = $1,142,857

Which EPS is higher if EBIT is RM1,500,000?

Issuing shares:

= (1,500,000 x ( 1 - 30%) - 10,000) / 2,000,000

= 0.52

Issuing bonds:

= ( ( 1,500,000 - 480,000) x ( 1 - 30%) ) / 1,200,000

= 0.59

Find out more on Indifference levels with EBIT at https://brainly.com/question/21436147.

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