Question

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 %

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%