Partick plc is planning to restructure its financing to introduce some gearing. The company has always been sufficiently profitable to finance its investments from retentions and has avoided the use of debt capital. The company’s finance director has discussed raising debt with the company’s investment bank and found that it will be possible to issue bonds to raise £180 million at a competitive interest rate of 6 per cent. The funds would be used to buy back 100 million shares at the prevailing share price of £1.80. The market has been kept informed of the company’s intentions and investors have reacted favourably to the proposal. The company has currently 400 million shares outstanding. The company’s expected earnings before interest and tax for next year has been estimated to be £100 million and the corporate tax rate is 40 per cent. 

a) Determine the expected earnings per share for the company with and without the financial restructuring. Does the difference in earnings per share provide a good basis for deciding between the two methods of financing? 

b) Discuss the view that the use of debt by a profitable company can increase the expected earnings per share and the expected rate of return on the equity, but this will not necessarily lead to an increase in the market price of the company’s shares. 

c) Discuss the contention that a company‘s capital structure decision involves a trade-off of the tax advantages of debt against the disadvantages of employing debt.

Answer rating: 100% (QA)

If Reconstruction is not done If Reconstruction is done fig in M fi... View the full answer