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    Nova Scotia General and Investment

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    Nova Scotia General is an all-equity firm. The firm has 200,000 shares of common stock outstanding, the
    EPS is $2, and all earnings are paid out to the shareholders as dividends. The current market value of the
    stock is $20 per share, and the opportunity cost of equity capital is 10 percent. General is considering two
    alternative plans to raise $3 million for a new and highly promising investment project, as follows:
    Plan A: Issue 150,000 more shares of common stock at $20 per share.
    Plan B: Issue $3 million of 9 percent coupon rate bonds.
    After the new investment, General expects EBIT to be $1,400,000. The tax rate is 35 percent.
    a) Calculate the EPS (and dividends per share) under each plan after the expansion.
    b) If the opportunity cost of equity stays at 10 percent when common stock is employed, what is the new
    market price per share?
    c) If bonds are used, the opportunity cost of equity capital increases to 12 percent. What is the new
    market price per share under that plan?
    d) Explain why the market price calculated in (b) is higher than the beginning market price of $20. Then
    explain why the market price calculated in c) is greater than that calculated in b). How does this
    relate to the basic business of the firm, and the financing employed?
    e) Which financing plan do you recommend? Why?

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    https://brainmass.com/business/issuing-equity/nova-scotia-general-investment-246298

    Solution Preview

    a)
    Plan A:
    EBIT = 1,400,000
    Interest = 0
    EBT=1,400,000
    Tax @35%=490,000
    EAT=910000
    No of shares=200000+150000=350000
    EPS=$2.60
    Since all earnings are paid out as dividend DPS will be same as EPS, So
    DPS=$2.60

    Plan B:
    EBIT = 1,400,000
    Interest = 3,000,000*9%=270,000
    EBT=1,130,000
    Tax @35%=395,500
    EAT=734500
    No of shares=200000
    EPS=$3.6725
    Since all earnings are paid out as dividend DPS will be same as EPS, So
    DPS=$3.6725

    b) Since all earnings are paid out as dividend, the growth rate in dividends will be zero
    P=D0*(1+g)/(k-g) = 2.60*(1+0%)/(10%-0%)=$26.00

    c) Since ...

    Solution Summary

    This solution shows step-by-step calculations to determine the EPS, dividends per share, market price per share, and recommends a strategy plan. Justifications are also included.

    $2.19

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