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Hello Sir, I hope you’re doing great!
Kindly, please help me understand this concept of PBIT indifference points in BPP study text….
( PBIT – interest) * (1-t)
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no. of shares after financing for plans 1 and 2In a ques after equating these two, PBIT=2500,
”At a level of PBIT above €2,500m, it will be better to issue debt, as every € extra of earnings will be distributed between fewer shareholders. At a level of PBIT below €2,500m, it will be better to issue equity, as the loss of each € will be shared by more shareholders. ”
I don’t understand this phrase… i mean if we issue more equity, isn’t the EPS going to dilute further, so like if we don’t issue any shares then SH suffer lesser decrease in EPS yeah?
I really need to see the whole question (and I do not have the BPP Study Text, only the Revision Kit). On what you have typed, then I agree with you final sentence.
Edted Company has 10,000m €1 shares in issue and wants to raise €5,000m to fund an investment by either:
(a) Selling 2,500m shares at €2 each, or
(b) Issuing €5,000m 10% loan stock at par.
The income tax rate is 40%.
In order to calculate the indifference point between issuing equity shares and issuing debt, we use the above equation.I actually don’t understand this : At a level of PBIT above €2,500m, it will be better to issue debt, as every € extra of earnings will be distributed between fewer shareholders. At a level of PBIT below €2,500m, it will be better to issue equity, as the loss of each € will be shared by more shareholders
If they issue shares then it is true that the EPS will be lower.
However if they issue loan stock, then although the number of shares will not change, the earnings to share will be lower because of having to pay the interest.
If the profit before interest and tax is P, then if they issue shares the EPS will be (P x 0.6)/12,500.
If instead they issue debt, then the EPS will be ((P – 500,000) x0.6) / 10,000The two EPS’s will be the same if the profit before interest and tax is $2,500,000
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