Financial management revision question and answer

United Steel has just been reorganized to produce industrial machinery. The company is in the process of establishing a financial policy and the following two alternative plans have been suggested.

Plan X: 2,000,000 ordinary shares of Sh.10 each. Sh.12,000,000 long term loan at 18% per annum.

Plan Y: 2,500,000 ordinary shares at Sh.10 each Sh.7,000,000 long term loan at 18% per annum.

The founders of United Steel have projected the following Earnings Before Interest and Taxes (EBIT).


The company‚Äüs marginal tax rate is 40%.

Required:
(a) (i)Calculate the expected Earnings Per Share (EPS) for each financial plan.

(ii) Which financial plan should be accepted? Why?

(b) Calculate the level of EBIT where the EPS are equal for the two plans.

ANSWER

(b)Accept plan X since it yields a higher E.P.S

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