Question 1 (20 MARKS)

Vaish Bhd and Kames Bhd are listed companies involved in the automobile industry. Both companies engage in assembling, marketing and distribution of passenger cars, commercial vehicles and four-wheel drives. Since both companies operate their businesses within the same industry, the inherent business risk of the companies is expected to be similar. Both companies maintain different capital structures. Kames Bhd maintains high gearing on the advice of its finance director. Vaish Bhds liquidity level is in a good position, so the company maintains a low gearing level.

During the recent Kames Bhds board of directors meeting, the chairman raised issues on different gearing levels, interest on debt and taxation. He questioned the finance director on the effect of high interest and taxation on earnings per share at different levels of gearing. He was curious about the effect on profit after tax for the different states of the economy and different sales levels.

Given below are the extracts of Vanish Bhds statement of profit or loss for next year at a different state of the economy.

State of economy	Moderate (RM000)	Good (RM000)
Revenue	5,730	8,680
Operating costs	(3,820)	(5,560)
Profit before interest and tax	1,910	3,120

Kames Bhds finance department has also forecasted the companys profit before interest and tax for next year. The expected profit before interest for the moderate economy will be RM1,920,000 and RM3,115,000 if the economy is good. Both companies pay tax at 20%.

All earnings are paid as dividends to their shareholders. The extract of the capital structures for both companies is as follows. Both companies have no intention to change their current capital structures.

	Kames Bhd	Vaish Bhd
	RM (000)	RM (000)
Share capital (RM1)	5,000	10,000
8% Debenture	7,000	2,000
Total capital	12,000	12,000

You are required to:

1. Calculate the profit after tax at different economic conditions for both companies.
   10. marks)

(CLO3:PLO6:C3) (CLO3:PLO6:C3)

2. Explain the reasons for the differences in the earnings per share (EPS) for both companies at the different levels of earnings and gearing.
   10. marks)

(CLO3:PLO6:C4) (CLO3:PLO6:C4)