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Beaver Co has 100 million equity shares in issue and has just reported a profit, after tax, of $55m.
A new issue of 50 million equity shares at an issue price of $1.50 is being considered. All proceeds would be used to redeem a bank loan with an annual cost of 8%. Beaver Co pays corporation tax at a rate of 20%.
Assume that operating profit (profit before interest and tax) remains constant. If the equity issue goes ahead and the bank loan is redeemed, what will be the new earnings per share figure?A0.399
B0.367
C0.598
D0.388Dear sir,
I believe the answer provided in the examiner report has a typo. Please check
Answer stated as A (55m+50m*1.5*0.08 X(1-0.2)
I think it should be 55m/0.8 +(50m *1.5*0.08) x 80%.
Thank you sir.I think it is
The correct answer is A.
We need to consider the profit after tax and the additional earnings from the equity issue.
The profit after tax is $55 million.The additional earnings from the equity issue can be calculated as follows:
50 million equity shares * $1.50 issue price * 8% annual cost of the bank loan * (1 – 20% tax rate) = $4 millionTherefore, the new earnings (profit after tax) would be $55 million + $4 million = $59 million.
To calculate the new earnings per share figure, we divide the new earnings by the total number of equity shares after the issue:
$59 million / (100 million + 50 million) = $0.399 per share.So, the new earnings per share figure would be $0.399.
I think it is:
The profit after tax is $55 million.
The additional earnings from the equity issue can be calculated as follows:
50 million equity shares * $1.50 issue price * 8% annual cost of the bank loan * (1 – 20% tax rate) = $4.8 millionTherefore, the new earnings (profit after tax) would be $55 million + $4.8 million = $59.8 million.
To calculate the new earnings per share figure, we divide the new earnings by the total number of equity shares after the issue:
$59.8 million / (100 million + 50 million) = $0.39866 per share.So, the new earnings per share figure would be $0.399.
Dear sir.
It says that all proceeds were used to redeem the loan.
The total proceeds from the issue is 75m(50m*$1.5) .
Does this imply that the 75m used to redeem covers the nominal value of the loan as well as the annual interest paid? Therefore nominal value is 6m(75m*92%)?
And how do we get 4.8m of additional earnings after redeeming the loan?
Thank you very much
Qs Beaver,i have replied to your reply under that thread sir.
Maybe it has started a new thread by mistake, if so I’m sorry.
Here’s the question,
Beaver Co has 100 million equity shares in issue and has just reported a profit, after tax, of $55m.
A new issue of 50 million equity shares at an issue price of $1.50 is being considered. All proceeds would be used to redeem a bank loan with an annual cost of 8%. Beaver Co pays corporation tax at a rate of 20%.
Assume that operating profit (profit before interest and tax) remains constant. If the equity issue goes ahead and the bank loan is redeemed, what will be the new earnings per share figure?A0.399
B0.367
C0.598
D0.388The annual interest cost saved by redeeming the bank loan would be 8% of the loan amount.
However, since the entire proceeds from the equity issue are used to redeem the loan, we do not have the exact nominal value of the loan provided in the information. Instead, we calculate the interest savings based on the proceeds, which are $75 million. The annual interest savings before tax would be $75m * 8% = $6m.
After considering the tax rate of 20%, the after-tax interest savings would be $6m * (1 – 0.2) = $4.8m.
Therefore, the additional earnings after tax, due to the interest savings, would be $4.8m. When this is added to the existing profit after tax of $55m, the new earnings would be $55m + $4.8m = $59.8m.
The new total number of shares after the equity issue would be 100 million existing shares plus 50 million new shares, totaling 150 million shares.
Finally, the new EPS would be calculated as follows: New EPS = New earnings / Total number of shares New EPS = $59.8m / 150m shares New EPS = $0.399
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