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(iii) Assuming debt finance is used, calculate the revised earnings per share after the business expansion.
This scenario relates to six requirements.
Tin Co is planning an expansion of its business operations which will increase profit before interest and tax by 20%. The company is considering whether to use equity or debt finance to raise the $2m needed by the business expansion.
If equity finance is used, a 1 for 5 rights issue will be offered to existing shareholders at a 20% discount to the current ex dividend share price of $5.00 per share. The nominal value of the ordinary shares is $1.00 per share.
If debt finance is used, Tin Co will issue 20,000 8% loan notes with a nominal value of $100 per loan note.
Financial statement information prior to raising new finance:
$’000
Profit before interest and tax
1,597
Finance costs (interest)
(315)
Taxation
(282)
Profit after tax
1,000
$’000
Equity
Ordinary shares
2,500
Retained earnings
5,488
Long-term liabilities: 7% loan notes
4,500
Total equity and long-term liabilities
12,488
The current price/earnings ratio of Tin Co is 12.5 times. Corporation tax is payable at a rate of 22%.
Companies undertaking the same business as Tin Co have an average debt/equity ratio (book value of debt divided by book value of equity) of 60.5% and an average interest cover of 9 times.
I don’t know why you have typed out the whole question – you presumably have an answer to it in the same book in which you found the question, and so I assume that you are not expecting me to type out an answer to it as well.
In answer to your actual question – tax is calculated on the profit after subtracting interest.
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