“Trading on equity is resorted with a view to decrease EPS”. Comment.

P6.1 A firm requires total capital funds of  25 lacs and has two options : All equity; and Half equity and Half 15%

debt. The equity share can be currently issued at  100 per share. The expected EBIT of the company is

 2,50,000 with tax rate at 30%. Find out the EPS under both the financial mix.

[Answer :  6 and  3.50 respectively.]

P6.2 AB Ltd. needs  10,00,000 for expansion. The expansion is expected to yield an annual EBIT of  1,60,000.

In choosing a financial plan, AB Ltd. has an objective of maximising earnings per share. It is considering the possibility of issuing equity shares and raising debt of

 1,00,000 or  4,00,000 or  6,00,000. The current market price per share is  25 and is expected to drop to  20 if the funds are borrowed in excess of

 5,00,000. Funds can be borrowed at the rates indicated below:

(a) up to  1,00,000 at 8%;

(b) over

 1,00,000 up to  5,00,000 at 12%;

(c) over

 5,00,000 at 18%. Assume a tax rate of 30%. Determine the EPS for the three financing alternatives.

[Answer:  2.96,  3.38 and  3.01.]

P6.3 The operating income of a textile firm amounts to

 1,86,000. It pays 30% tax on its income. Its capital structure consists of the following :

15% Preference shares  1,00,000.

Equity shares ( 100 each) 4,00,000 14% Debentures 5,00,000

(i) Determine the firm’s EPS.

(ii) Determine the percentage change in EPS associated with 30% change (both increase and decrease)

in EBIT.

(iii) Determine the degree of financial leverage at the current level of EBIT.

(iv) What additional data do you need to compute operating as well as combined leverage?

[Answer : EPS  16.55 and Financial Leverage 1.97.]

P6.4 Three financing plans are being considered by ABC Ltd. which requires  10,00,000 for construction of a new plant. It wants to maximize the EPS and the current market price of the share is