Mr. Marcelo has a burgeoning stock brokerage firm and he wants to expand his operations and compete

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Question:

Mr. Marcelo has a burgeoning stock brokerage firm and he wants to expand his operations and compete in the global stock brokerage industry. Mr. Marcelo has an external funding requirement amounting to P50,000,000.00 for the said expansion. He is contemplating on whether to use debt financing or equity financing for him to generate the abovementioned external funding requirement. After the expansion, he expects that his operating expenses and cost of service will remain constant at 40% of the company’s revenue. His options in generating the P50,000,000 are as follows:

1. Sell 2,000,000 new shares of common stock at a net price of P25 per share; or

2. Sell P50,000,000, premium bond at an interest of 10%. The maturity would be 30 years, and the bond is predetermined as callable.

Additional Information:

a) In a bust economy, Mr. Marcelo can earn a gross revenue of P15,000,000.00 and in a boom economy, he can earn a gross revenue of P25,000,000.00

b) Mr. Marcelo’s stock brokerage firm has no outstanding debts.

c) Mr. Marcelo pays P1,500,000 annually for the dividends of his preferred shareholders.

d) Tax rate is at 40%

e) If debt financing will be used, total interest expense is P 4,000,000 and if equity financing will be used, total interest expense is P1,500,000.

f) Mr. Marcelo’s stock brokerage firm currently has a total of 4,000,000 outstanding common shares.

REQUIRED:

1. Identify the crossover point of equity and debt financing using the range of earnings chart. Show complete solutions. (40 points)

2. As the financial consultant of Mr. Marcelo, what type of financing are you going to suggest if the forecasted earnings before interest and taxes of Mr. Marcelo after the expansion is P22,000,000.00? (10 points)