Question

21. Phu Lighters has the following assets: Current assets. Capital Assets ........ $1,750,000 Total ......................... 3,000,000 $4,750,000 During 3 months of the year, current assets drop to $400,000. Its operating profit (EBIT) is expected to be $620,000. Its tax rate is 40 percent. Shares are valued at $10. Its capital structure is short-term financing at 3 percent and long-term financing of 50 percent equity, 50 percent debt at 6 percent. a. Calculate expected EPS if the firm is perfectly hedged. b. Calculate expected EPS if Phu is a more aggressive with its capital structure and finances all current assets and 20 percent of its capital assets with short-term loans. c. Recalculate a and b if short-term rates go to 8 percent while long-term rates remain the same.

Answer 1

Hi,

Please find below the calculation. since the image file exceeding the allowed limit hence pasting the calculation below.

Particulars	Information
Current Assets	$       1,750,000
Capital Assets	$       3,000,000
Total	$      4,750,000
Expected EBIT	$          620,000
Tax Rate	40%
Debt Interest Rate	6%
Short Term Rate	3%
Long Term Finance
Equity (50%)	$       1,500,000
Debt (50%)	$       1,500,000
No of Shares
Equity Value/Share	$                    10
No of Shares	150,000

Reply to Question - a
Assuming short term loan was equivalent to current assets in first 3 Months i.e.$1,750,000 and for rest of 9 months it was $400,000
EPS Calculation
Expected EBIT	$          620,000
Interest
Short term
@3% on $1,750,000 for 3 Months	$          (13,125)
@3% on $400,000 for 9 Months	$            (9,000)
Long Term Debt
@6% for $1,500,000 for 12 Months	$          (90,000)
Net profit before Tax	$         507,875
Tax @40%	$       (203,150)
Profit after Tax	$         304,725
EPS (Earning Per Share)	$               2.03	(profit after tax / No of Shares)

Reply to Question - b
Revised Calculation for Short Term & Capital Loan
Short Term Loan (For Current Assets)	$       1,750,000	For 3 Months
Short Term Loan (For Current Assets)	$          400,000	For 9 Months
Short Term Loan (For Capital Assets)	$          600,000	20% of Capital assets of $3,000,000
Assuming 50% equity and 50% debt against remaining capital assets
Long Term Finance
Equity (50%)	$       1,200,000
Debt (50%)	$       1,200,000
No of Shares
Equity Value/Share	$                    10
No of Shares	120,000
EPS Calculation
Expected EBIT	$          620,000
Interest
Short term
@3% on $1,750,000 for 3 Months	$          (13,125)
@3% on $400,000 for 9 Months	$            (9,000)
@3% on $600,000 for 12 Months	$          (18,000)
Long Term Debt
@6% for $1,200,000 for 12 Months	$          (72,000)
Net profit before Tax	$         507,875
Tax @40%	$       (203,150)
Profit after Tax	$         304,725
EPS (Earning Per Share)	$               2.54	(profit after tax / No of Shares)

Reply to Question - c
Situation 1
EPS Calculation
Expected EBIT	$    620,000
Interest
Short term
@8% on $1,750,000 for 3 Months	$    (35,000)
@8% on $400,000 for 9 Months	$    (24,000)
Long Term Debt
@6% for $1,500,000 for 12 Months	$    (90,000)
Net profit before Tax	$   471,000
Tax @40%	$ (188,400)
Profit after Tax	$   282,600
EPS (Earning Per Share)	$          1.88	(profit after tax / No of Shares)
Situation 2
EPS Calculation
Expected EBIT	$    620,000
Interest
Short term
@3% on $1,750,000 for 3 Months	$    (35,000)
@3% on $400,000 for 9 Months	$    (24,000)
@3% on $600,000 for 12 Months	$    (48,000)
Long Term Debt
@6% for $1,200,000 for 12 Months	$    (72,000)
Net profit before Tax	$   441,000
Tax @40%	$ (176,400)
Profit after Tax	$   264,600
EPS (Earning Per Share)	$          2.21	(profit after tax / No of Shares)