Question

3. Sydney Rangers Inc operates remote parking lots near major airports. The board of directors of this family-owned company believes that Sydney Rangers could earn an additional $2 million income before interest and taxes by expanding into new markets. However, the $5 million that the business needs for growth cannot be raised within the family. The directors, who strongly wish to retain family control of the company, must consider issuing securities to outsiders. Sydney Rangers's Plan 1 is to borrow at 6%. Plan 2 is to issue 100,000 common shares. Plan 3 is to issue 100,000 non-voting, $3.75 preferred shares ( $3.75 is the annual dividend paid on each preferred share). Sydney Rangers currently has net income of $3.5 million and 1 million common shares outstanding. The company's income tax rate is 25% (20 marks) Requirements: 1. Prepare an analysis to determine which plan will result in the highest earning per common share. 2. Recommend one plan to the board of directors. Explain your reasons.

Answer 1

ans)

According to the above question, the present eps is 3.5 i,e,(3500000/1000000)

the question clearly mentions that the family doesn't want to dilute the control of the firm. Therefore the firm will not go for equity financing. This will dilute the control of the business, as the equity shares having voting rights.

1) The present EPS is 3.5/-

according to plan A,

the EPS would be 4.775 (5000000 mn borrowed money @ 6% p.a i,e, 300000. therefore h

2000000-300000 = 1700000+(1700000*0.25 = 425000) intotal (1275000+ 3500000)/1000000

here the net income is 4775000 and EPS is 4.775/-

according to plan B,

equity shares are issued. But the management of the company don't want to dilute the control over the business.therefore the management may not adopt plan B. even though the calculated net income after interest and tax will be (2000000*.25 = 500000.). therefore 1500000+3500000 = 5,000,000 / 1,100,000 = EPS = 4.54/-

according to Plan C,

company issue preferred equity shares @ 3.75 * 100000 which is 375000. (2000000 - 500000(tax) - 3750000 (preference dividend) = 1125000.Therefore 3500000+1125000 = 4625000 / 1000000 = EPS = 4.625/-

2) On the basis of computations given above Plan A is advisable for the management as the inclusion of debt fund not only increased the EPS but also reduced the chance of control dilution of the currently operating unit.