Question

SpringTime Ltd is considering the following two alternatives for financing extensions. 1. Issue 68,000 shares at...

SpringTime Ltd is considering the following two alternatives for financing extensions. 1. Issue 68,000 shares at $21 per share. (Cash dividends have not been paid; nor is the payment of any cash dividend contemplated.) 2. Issue 10%, 10-year debentures at face value for $1,428,000. (Assume that 10% is also the market rate for similar securities.) It is estimated that the company will earn $513,000 before interest and taxes as a result of the extension. The company has an estimated tax rate of 30% and has equity of $2,164,000 prior to the new financing. Required Determine the effect on profit and return on ordinary shareholders’ equity for: (a) issuing shares (b) issuing debentures. (Round return on equity to 2 decimal places, e.g. 15.27%.) SpringTime Ltd (a) Issue shares Profit $ Return on equity % Issue of debentures Profit $ Return on equity %

Homework Answers

Answer #1

before issue

profit after tax :- 513000-153900(30% )= 359100

total equity share = 2164000

return on equity = 359100/2164000*100=16.59%

(a) issuing share

profit after tax :- 513000-153900(30% )= 359100 . profit remain same

total equity share = 2164000 + 1428000=3592000

return on equity = 359100/ 3592000 * 100 = 9.99%

(b) issuing debentures

profit after tax and interest = 513000- 142800-111060=259140. profit gets reduced

total equity share =2164000

return on equity = 259140/2164000*100=11.97%

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