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Homework answers / question archive / The VidalE Corporation is considering three possible financing arrangements to raise $10,000 of new capital
The VidalE Corporation is considering three possible financing arrangements to raise $10,000 of new capital. Currently, the capital structure of Vidale Corporation consists of no debt and $10,000 equity. There are 500 shares of common stock currently outstanding, currently selling at $20 per share. The VidalE Corporation is expected to generate $12,000 of EBIT next period. It is expected that interest rate on any debt would be 10%. The three possible financing alternatives are: Alternative 1: All equity financing. Alternative 2: 50% debt and 50% equity financing Alternative 3: All debt financing a) Calculate the following items for each alternative financing, assuming that there are no taxes imposed on corporate income: (15 pts.) Earnings to owners Earnings per share (EPS) Distribution of income between creditors and shareholders. b) Calculate the following items for each alternative financing, assuming that the marginal tax rate on corporate income is 30%: (15 pts.) Earnings to owners Earnings per share (EPS) Distribution of income between creditors and shareholders. c) Calculate the EBIT-EPS analysis of Alternative 1 and 2; and Alternative 1 and 3. Interpret/analyze your answer to these combinations. (20 pts.)
Equity = $10000
Amount to be raised = $10000
No. of shares = 500
EBIT = $12000
Int on any Debt = 10%
When tax rate is 0
Alternative 1 : All equity financing
amount to be raised = $10000
MP per share = $20
No of shares = 10000/20 = 500shares
Total no. of shares = 500+ 500 = 1000 shares
| Particulars | Amount |
| EBIT | $12000 |
| Less: Interest | 0 |
| EBT | $12000 |
| Less: Tax | 0 |
| EAT | $12000 |
Earnings to owners = $12000
EPS = $12000 / 1000 = $ 12 per share
Distribution among creditors = $0
Distribution among shareholders = $12000
Alernative 2 : 50% Debt and 50% equity
Debt raised = $10000 * 50% = $5000
Int on debt = $5000 * 10% = 500
Equity raised = $5000 / 20 = 250shares
Total No. of shares = 500 + 250 = 750 shares
| Particulars | Amount |
| EBIT | $12000 |
| Less: Interest | -500 |
| EBT | $11500 |
| Less: Tax | 0 |
| EAT | $11500 |
Earnings to owners = $11500
EPS = $11500 / 750 = $ 15.33 per share
Distribution among creditors = $500
Distribution among shareholders = $11500
Alternative 3 : All Debt financing
Debt raised = $10000
Int on Debt = $10000 * 10% = $1000
| Particulars | Amount |
| EBIT | $12000 |
| Less: Interest | -1000 |
| EBT | $11000 |
| Less: Tax | 0 |
| EAT | $11000 |
Earnings to owners = $11000
EPS = $11000 / 500 = $ 22 per share
Distribution among creditors = $1000
Distribution among shareholders = $11000
EBIT EPS analysis for alternative 1 and alternative 2
| Particulars | Alternative 1 | Alternative2 | Alternative 3 |
| EPS | 12 | 15.33 | 22 |
Alternative 3 is good option
Alternative 1 and 2
Let EBIT be X
X/1000 = (X - 500)/750
X = $2000
$2000 EBIT gives same EPS under both alternatives.
Alternative 2 and 3
Let EBIT be X
(X - 500)/750 = (X - 1000)/500
X = $2000
$2000 EBIT gives same EPS under both alternatives.
When tax rate is 30%
Alternative 1 : All equity financing
amount to be raised = $10000
MP per share = $20
No of shares = 10000/20 = 500shares
Total no. of shares = 500+ 500 = 10000 shares
| Particulars | Amount |
| EBIT | $12000 |
| Less: Interest | 0 |
| EBT | $12000 |
| Less: Tax @ 30% | -3600 |
| EAT | $8400 |
Earnings to owners = $8400
EPS = $8400 / 1000 = $ 8.4 per share
Distribution among creditors = $0
Distribution among shareholders = $8400
Alernative 2 : 50% Debt and 50% equity
Debt raised = $10000 * 50% = $5000
Int on debt = $5000 * 10% = 500
Equity raised = $5000 / 20 = 250shares
Total No. of shares = 500 + 250 = 750 shares
| Particulars | Amount |
| EBIT | $12000 |
| Less: Interest | -500 |
| EBT | $11500 |
| Less: Tax @ 30% | - 3450 |
| EAT | $8050 |
Earnings to owners = $8050
EPS = $8050 / 750 = $ 10.73 per share
Distribution among creditors = $500
Distribution among shareholders = $8050
Alternative 3 : All Debt financing
Debt raised = $10000
Int on Debt = $10000 * 10% = $1000
| Particulars | Amount |
| EBIT | $12000 |
| Less: Interest | -1000 |
| EBT | $11000 |
| Less: Tax @ 30% | -3300 |
| EAT | $7700 |
Earnings to owners = $7700
EPS = $7700 / 500 = $ 15.4 per share
Distribution among creditors = $1000
Distribution among shareholders = $7700
EBIT EPS analysis for alternative 1 and alternative 2 and alternative 3
| Particulars | Alternative 1 | Alternative2 | Alternative 3 |
| EPS | 8.4 | 10.73 | 15.4 |
Alternative 3 is good option
Alternative 1 and 2
Let EBIT be X
(X-30%)/1000 = ((X - 500)-30%)/750
X = $2000
$2000 EBIT gives same EPS under both alternatives.
Alternative 2 and 3
Let EBIT be X
((X - 500)-30%)/750 = ((X - 1000)-30%)/500
X = $2000
$2000 EBIT gives same EPS under both alternatives.
