TMA Template
Currently, Nakami does not have any borrowings. Management forecast that revenue for FY 2016 will increase to $13.5 million, while gross profit margin remains constant. Operating expenses will increase by 3% and corporate tax rate remains at 17%.
Sharon met up with the firm's bankers recently and understand that they are willing to extend a term loan of $10 million to Nakami and the borrowing rate is 8%. The proceeds from this loan will be used for share repurchase.
She wants to evaluate the firm's optimal capital structure. Currently, there are 6 million ordinary share outstanding and each share is valued at $5.00.
(a) Calculate the earnings per share for FY 2016 under the following scenarios:
- (i) Without any borrowings
- (ii) If the firm borrows $5 million
- (iii) If the firm borrows $10 million
Advise Sharon which capital structure the firm should adopt and why.
- (b) Discuss whether the company can issue bonds to repurchase the shares advisable and whether use of earnings per share as the criterion is appropriate in capital structure decision.
- (c) Generally, companies with high operating leverage will tend to have a high financial leverage. Critically analyse this statement.