Question

Question 3

Naveed SAOG finances their all projects by using both owned and borrowed capital. It includes the following combination:

Ordinary shares	10000 shares of OMR 5.100 each
8%-Debentures	15000 debentures of OMR 10.500 each

(a) Identify the differences between owned capital and borrowed capital by referring to the information above and other sources of owned capital and borrowed capital.

Naveed SAOG is considering two plans to buy a new machine for OMR 200000. Plan A involves issuance of 50000 shares of common stock at the current market price of OMR 3 per share and 10000 shares at OMR 5 per share. Plan B involves issuance of OMR 150000, 12% bonds and OMR 50000, 24% debentures at face value.

Income before interest and taxes on the new machine will be OMR 300000. Income taxes are expected to be 25%. Naveed SAOG currently has 10000 shares of common stock outstanding and Interest-bearing bonds of OMR 25000 at a rate of 9% per year.

(b) Calculate basic Earnings Per Share (EPS) under the both plans and select the best cause of action from the viewpoint of existing shareholders.

Answer 1

a)

Owned Capital: Capital that the company owns and there is no fixed liability attached this capital.

Ordinary shares, preference share and ploghbacked profits form owned capital.

Borrowed capital: Capital arranged from outside the firm for a fixed liability which is an obligation.

Bank loans, debentures and public deposits are borrowed capital.

b)

	A	B
	50000 shares @ OMR 3	OMR 150000 @ 12%
	10000 shares @ OMR 5	OMR 50000 @ 24%
Machine Cost	200000	200000
EBIT	300000	300000
Interest Exp	0	30000	For B: 18000 + 12000
EBT	300000	270000
Tax	75000	67500
Net Profit	225000	202500
Outstanding shares	70000	10000	For A: 10000 + 50000 + 10000
EPS	3.21	20.25

Existing shareholders will prefer Option B because EPS is higher and their holding is not diluted.