Capital Structurs Decisions
CAPITAL STRUCTURE DECISIONS
When a firm is seeking financing for a project it is usually a choice between additional debt financing or an additional equity issue, assuming internally generated funds are not sufficient.
The chosen option of financing can make a difference to EPS (earnings per share ), which is an important investment analyst ratio.
Example :
Assume Cherokee Tire Co’s long term capitalization of $18 mill is as follows :
Debt $5 mill @ 9 per cent. Shareholders Equity $13 mill.
The company wishes to raise $5 mill for expansion. It has 3 options ;
i. Issue 100,000 new common stock @ $50.00 each ii. Issue new debt @ 8% iii. Issue preferred stock with a 7.6 % dividend.
Present EBIT are $3 mill, and corp. tax rate is 40%
There are 400,000 shares of common stock presently outstanding.
Suppose EBIT is expected to move to $4 mill after expansion, what would EPS be under each financing option.
Common Stock Debt Pref. Stock $ $ $
Estimated EBIT 4,000,000 4,000,000 4,000,000 Interest on existing debt 450,000 450,000 450,000 New debt interest ---- 400,000 ………. Earnings before taxes 3,550,000 3,150,000 3,550,000 Taxes @ 40% 1,420,000 1,260,000 1,420,000 After tax earnings 2,130,000 1,890,000 2,130,000 Preferred dividend 380,000
When a firm is seeking financing for a project it is usually a choice between additional debt financing or an additional equity issue, assuming internally generated funds are not sufficient.
The chosen option of financing can make a difference to EPS (earnings per share ), which is an important investment analyst ratio.
Example :
Assume Cherokee Tire Co’s long term capitalization of $18 mill is as follows :
Debt $5 mill @ 9 per cent. Shareholders Equity $13 mill.
The company wishes to raise $5 mill for expansion. It has 3 options ;
i. Issue 100,000 new common stock @ $50.00 each ii. Issue new debt @ 8% iii. Issue preferred stock with a 7.6 % dividend.
Present EBIT are $3 mill, and corp. tax rate is 40%
There are 400,000 shares of common stock presently outstanding.
Suppose EBIT is expected to move to $4 mill after expansion, what would EPS be under each financing option.
Common Stock Debt Pref. Stock $ $ $
Estimated EBIT 4,000,000 4,000,000 4,000,000 Interest on existing debt 450,000 450,000 450,000 New debt interest ---- 400,000 ………. Earnings before taxes 3,550,000 3,150,000 3,550,000 Taxes @ 40% 1,420,000 1,260,000 1,420,000 After tax earnings 2,130,000 1,890,000 2,130,000 Preferred dividend 380,000