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    Gearing and Calculating Earnings Per Share

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    Tobi Industries wishes to undertake a project that will cost R2 500 000. The project has already been evaluated and has a positive net present value. The decision now facing management is how to finance the project. Three alternative financial "packages" are under consideration:
    - Issue 1250 000 new ordinary shares at 200 cents each, or
    - Issue R2 500 000 Debenture, due in 2020 at a fixed rate of interest 7%, or
    - Issue 1 000 000, 15%, R2.50 preference shares.

    The project is expected to generate an extra R500 000 of earnings (before interest and tax) each year. The company pays tax at 30% and follows a policy of paying a constant ordinary dividend per share.
    The current abridged income statement and balance sheet are as follow:
    Abridged Income statement Rand
    Operating profit 2,200,000
    Interest 600,000
    Profit before tax 1,600,000
    Tax 480,000
    Profit after tax 1,120,000
    Dividend 320,000
    Retained Income 800,000

    Abridged Balance Sheet
    Non Current Assets 7,000,000
    Current Assets 6,000,000
    13,000,000
    Share capital and Reserves 8,250,000
    Ordinary Share Capital (50 cents) 1,000,000
    Retained Income 7,250,000
    Non- current liabilities: 16% Debenture, due in 2017 3,750,000
    Current liabilities 1,000,000
    13,000,000
    Required:
    3.1 Calculate the current earnings per share (EPS)
    3.2 Calculate the current gearing (non-current debt/equity, using book value.
    3.3 Calculate the revised EPS and gearing using ordinary share financing.
    3.4 Calculate the revised EPS and gearing using debenture financing.
    3.5 Calculate the revised EPS and gearing using preference share financing.
    3.6 Prepare a brief report, with supporting evidence, recommending which of these three financing sources the company should use. (Average gearing level of the industry is 90%).

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    https://brainmass.com/business/financial-ratios/gearing-calculating-earnings-share-502998

    Solution Preview

    See the attached file.
    3.1 Calculate the current earnings per share (EPS)
    Profit after tax 1,120,000
    Number of shares 2,000,000 = ordinary share capital (1,000,000)/.50
    Earnings per share (EPS) 0.56 =1,120,000/2,000,000

    3.2 Calculate the current gearing (non-current debt/equity, using book value.
    Non-current debt 3,750,000
    Total equity and reserves 8,250,000
    Gearing/Debt ratio 45.45% = non-current debt/total equity and reserves

    3.3 Calculate the revised EPS and gearing using ordinary share financing.
    Operating profit 2,700,000 = 2,120,000 + 500,000
    Interest 600,000
    Profit before tax 2,100,000 = 2,700,000 - interest
    Tax 630,000 = 30% * 2,100,000
    Profit after tax 1,470,000 = 2,100,000 - 630,000

    Profit after tax 1,470,000
    Number of ...

    Solution Summary

    The solution discusses gearing and calculating earnings per share.

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