Question

Suppose the management of Emaar company is anticipating business growth in near future, and hence wants to develop an asset financing plan. The Chief Financial Officer of the company presented some facts and figures to the management with regard to various assets, financing options, and various capital costs. The company seems to have AED 32 billion worth of current assets, of which 20% are permanent, and AED 80 billion in fixed assets. The company has borrowed in the past from financial institutions and several other sources. The CFO believes that the company can borrow more funds as per requirements either on long-term basis or short-term basis. The current long-term rate is 8% and the short-term rate is 6%. Since the UAE is under no-tax regime, the corporate tax rate can be assumed to be 0%. Based on the above information, you are required to construct two financing plans - one conservative, with 75% of assets financed by long-term sources, and the other aggressive, with only 50% of assets financed by long-term sources. If Emaar company’s 2019 earnings before interest and taxes are approximately AED 9 billion, calculate net income under each alternative. Do you think each of the alternatives has some specific risks? Explain. After comparing the two plans, which plan would you recommend to Emaar company’s management? Provide your arguments?

Answer 1

Total Assets Emmar Company has: -
Particulars			Amount
			(AED) in billions
Current Assets
Permanent	6.4
Working	25.6		32
Fixed Assets			80
Total Assets			112

			(AED) in billions
Particulars		Alternative 1	Alternative 2
		(75% asset finance)	(50% asset finance)
Long-term sources		84	56
Short-term sources		28	56
Earning before interest & taxes (EBIT)		9	9
Less:- Interest @ 8%		6.72	4.48
Interest @ 6%		1.68	3.36
PAT		0.6	1.16
Financial Degree (EBIT/PAT)		15.00	7.76
		Conservative	Aggressive
Specific Risk			Leverage
Alternative 2 is recommeded