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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 price of the bonds to be issued, and the selling price of the shares, the indifference level of EBIT between the plans is $1,142,857.

Between issuing shares and issuing bonds, the one with the higher EPS will be Issuing Bonds with EPS of 0.59

What is the indifference level?

First find the number of shares if the plan is to issue shares:

= Current number of shares + New shares

= (2,400,000 value / Price per share) + (4,000,000 / $5 Price per new share)

= 2,000,000 shares

The interest if bonds are picked is:

= 12% coupon x Bond value

= 12% x 4,000,000

= $480,000

Assuming the indifference level is denoted as L, the indifference level is:

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

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

L = $1,142,857

Which plan gives the higher EPS?

Issuing bonds:

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

= 0.59

Issuing shares:

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

= 0.52

Find out more on Earnings Per Share (EPS) at https://brainly.com/question/11448221.

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