- March 3, 2021 at 10:20 am #612968adarsh1997Participant
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GXG Co is considering an issue of $3,200,000 of loan notes paying annual interest of 6%. Investment
of the funds raised would increase operating profit by $576,000 per year.
Recent financial information relating to GXG Co is as follows:
Operating profit 3,450
Profit before taxation 3,250
Profit after taxation 2,600
Which of the following would occur following the loan note issue?
(1) Earnings per share would fall
(2) The cost of equity would rise
(3) Tax shield would rise
A 1, 2 and 3
B 2 and 3 only
C 2 only
D 3 only
1. The answer is B.
2. Why the first statement is incorrect?
– With additional loans, we will need additional interest to pay and therefore earning will decrease. Please advise where I’ve got things wrong?
ThanksMarch 3, 2021 at 1:34 pm #613024John MoffatKeymaster
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The earnings will increase because the operating profit will increase by $576,000 which is more than the interest payable of $192,000.
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