Question

Olivia has just graduated from University and was hired by Manutech Inc. to help out with the company's financing decisions. The company has very high profit margins and generates large amounts of free cash flow. It currently has $500,000 in total assets and 10,000 shares outstanding. Because of generous investment tax credits and high rates of depreciation, Manutech does not pay any corporate tax. Manutech currently is all equity financed. The Chief Financial Officer ask Olivia to develop a financial strategy that could increase shareholder value. Olivia spends a week going over the company's financials, Olivia determines that there are three possible profit scenarios. Under the first scenario (recession), operating profits (EBIT) a S10,000 per year. Under the second scenario (expected), operating profits are $25,000 per year. Under the third scenario (expansion), operating profits are $40,000 per year re Olivia proposes the following plan, which will increase average earnings per share and return o equity. More specifically, she proposes that Manutech borrows money from a bank and use the proceeds to repurchase shares. As a result of this transaction, Manutech would have a debt-to- equity ratio of 2. The cost of borrowing from the bank is Please answer the following questions and document each step of your work (points will be deducted for not doing so). You must include a cover page with your submission.

Answer 1

File Home InsertPage LayoutFormulas DataReview View DeveloperNitro Pro8 5 EX Times New Roman, 12 , A. A »- wrap Text Copy Format Painter B 1 u.-B, 3-Δ.-= 国Merge & Center, E. % 凋ぷ oamat ,StCell, , Insert Delete Format Sort & Find & Format Painter 2 ClearF Select Editing Formatting as Table Styles Clipboard Font Alignment Number Cells E21 Recession Scenario Expansion Scenario Particulars EBIT Less: Interest Profit before Tax Less. Tax @ 34% Earnings available for Equity Share Holder (EAESH no. of share Earnings Per Share Amount (in Particulars EBIT Less: Interest Profit before Tax Less. Tax @ 34% Earnings available for Equity Share Holder EAESH) no. of share Earnings Per Share Amount (in 10000 10000 40000 10000 30000 10200 19800 3333.33 5.94 0 3333.33 10 12 Expected Scenario Working Note Particulars Amount (in Total Asscts 500000 25000 10000 15000 5100 9900 3333.33 2.97 14 15 16 Value of Debt (500000 2/3) Less: Interest Profit before Tax Less. Tax @ 34% Earnings available for Equity Share Holder (EAESH no. of share Earnings Per Share 333333.33 Interest on Debt (33333333°3%) Value per equity share ($500000/10000 shares) no. of share re-purchased no. of remaining shares 50 6666.67 3333.33 18 19 20 Sheet1 Sheet2 Sheet3 Ready

Shareholder's value will be greater under expansion scenario because retained earnings after paying interest to debt holders is highest in the expansion scenario.

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