The company is now considering an investment of $25 million. This will add $5 million each year to profit! before interest and tax.
a) There are 2 ways of financing this investment. One would be to borrow $25 million at a cost of 8% pa ir interest. The other would be to raise the money by a means of a 1 to 4 rights Issue.
b) Whichever financing method is used, the company will Increase dividends per share next year from 32,5c to 35c.
c) The company does not intend to allow its gearing level, measured as debt finance as a proportion of equity capital plus debt finance, to exceed 55% at the end of any financial year. In addition, the company will not accept any dilution In earnings per share.
Assume that the rate of taxation will remain at 30% and that debt interest costs will be $6 million plus the Interest cost of any new debt capital.
Required
1 Produce a profit forecast (profit after tax, dividends and retained profits) for next year, assuming that the new project Is undertaken and is financed i) by debt capital 10 by a rights Issue.
2 Calculate the earnings per share next year, with each financing method.
3 Calculate the effect on gearing as at the end of next year with each financing method.
4 Explain whether either or both methods of funding would be acceptable.
Attachment:- Article.rar