Module07Tutorial - September 2003 FIN2101 BUSINESS FINANCE...

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FIN2101 BUSINESS FINANCE II MODULE 7 - CAPITAL STRUCTURE QUESTION 1 The Uthinko Company Ltd is comparing two different capital structures, an all-equity plan (Plan 1) and a levered plan (Plan 2). Under Plan 1, Uthinko would have 20 000 shares outstanding. Under Plan 2, Uthinko would have 10 000 shares and $50 000 in debt outstanding. The interest rate is 12% and the tax rate is 30%. a) If EBIT is $10 000, which plan will result in the higher EPS? b) If EBIT is $20 000, which plan will result in the higher EPS? c) What is the breakeven EBIT, ie the indifference point for the 2 plans? QUESTION 2 Lynch-Lyons Ltd has decided to finance a $4 million expansion program by issuing either ordinary shares or debentures. Currently the firm has 200 000 ordinary shares outstanding and no long-term debt. Ordinary shares can be sold to net $40 per share. The debenture issue will be a 25-year issue at 12% interest. The tax rate is 30%. a) Assuming that the program will give rise to earnings before interest and taxes (EBIT) of $1.5 million, calculate the expected earnings per share (EPS) for the two (2) alternative financing plans. b) Construct a simple EBIT-EPS graph which would indicate which of the financing plans should be preferred. c) Calculate mathematically the breakeven level of EBIT, ie the indifference point for the two plans. d)
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Module07Tutorial - September 2003 FIN2101 BUSINESS FINANCE...

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