Question

Written report

\You are the CFO of Axis Trading Group (ATG). Together with the Financial Controller, you are responsible for evaluating the financial performance and devising a strategy for financial sustainability for ATG. The key objective of the report is to devise an implementation plan for the continual growth of the company to enable financial stability and sustainability. The written report, along with a five-minute presentation, will be submitted at the next management meeting. Your report needs to be professionally presented. This requires that it be word-processed with calculations detailed.

Additional information

As part of its financial stability and sustainability, ATG is considering the acquisition of another subsidiary company, ALH Company (ALH). To fund the acquisition the company requires $3,000,000. You have proposed two alternatives to fund the acquisition: 

Issue 1,500,000 $2 ordinary shares 

Issue 30,000 $100 13% debentures

Assume the following existing capital structure of: 

2,000,000 $2 ordinary shares $4,000,000 

750,000 $1.50 8% Preference shares $1,125,000 

40,000 $100 11% Debentures $4,000,000

It is predicted that the acquisition will increase the company’s Earnings Before Interest and Tax (EBIT) to $1,800,000. The company tax rate is 30%.

Before you start compiling your report, ensure that you undertake the following calculations: 

calculate the Earnings per share for each option. 

calculate the EBIT at the indifference point. 

calculate the Degree of financial leverage 

calculate the Goodwill (if any) assuming that the Net Assets of ALH are $2,125,000.

Completing your Report:

Part 1

Provide answers to the following questions:

I). What is the EPS under each option?

II). What is the EBIT at the indifference point?

III). Provide an explanation of the indifference point.

IV). What is the degree of Financial Leverage?

V). What is your recommendation as to the most appropriate option based on EPS?

VI). What is the Goodwill on acquisition?

VII.) Discussion of other factors to be considered.

VIII). The information on which your calculations are made have been audited and comply with financial legislation. Does this have any impact on the results of your evaluation?

IX). Include your calculations as Appendix 1 in the report.

Answer 1

Solution as detail below for both proposed plans:

1. EPS as computed in Each plan as under:

A. Plan 1 Equity

EPS = EAT/(Share o/s)

EPS is $0.30 when we take increase in EBIT by 50% & EPS will also increase by 50% from $0.20 to $0.30

B. Plan II Debt

EPS will be $0.36 when we take increase in EBIT by 50% then EPS will increase from $0.21 to $0.36. with the change in EBIT with 50% the EPS changed by 74%.

2. EBIT at Plan 1 equity is $1.8 Million after taking acquisition & it record a growth of 50% in EPS respectively. While in Plan II debt EBIT increase with 50% & EPS record an increase in 74%

3. It is the level of volume at which total costs, and profits, are the same under both cost structures

Suppose product A has = 10000 Fixed cost & 10 variable

& Product B has = 40000 Fixed Cost & 7 Variable

Then product A=Product B

10000+10A = 40000+7A

3A=30000

A=10000 Volume

4. Degree of Financial Leverage will be for Plan I Equity is 1 & for Plan II Debt it will be 1.48 which was calculated by % change in EPS/ % change in EBIT.

DLF = % Change in EPS/% Change in EBIT

Detailed solution as under:

A. Plan I Equity
EBIT	1200000		1800000
Int.	0		0
EBT	1200000		1800000
Tax @30%	360000		540000
EAT	840000		1260000
Shares O/S	4250000		4250000
EPS	0.20		0.30
% change in EPS			50%
% change in EBIT			50%
DFL			1
B. Plan 2 Debenture
EBIT	1200000		1800000
Int.	390000		390000
EBT	810000		1410000
Tax @30%	243000		423000
EAT	567000		987000
Shares O/S	2750000		2750000
EPS	0.21		0.36
% change in EPS			74%
% change in EBIT			50%
DFL			1.48