Question

A new company needs Rs 5,00,000 for construction of a new plant. The following 3 financial plans seem feasible.
Plan 1: The company may issue 5000 ordinary shares @ Rs 10 / share
Plan 2: The company may issue 25000 ordinary shares @ Rs 10/share and 2500 debentures of Rs 100 @ 8% interest
Plan 3: The company may issue 25000 ordinary shares @ Rs 10 / share and 2500 preference shares of Rs 100 bearing 8% dividend.
If the company’s EBIT is expected to be Rs 1,00,000, what would the EPS be under the 3 plans? Which alternative would you recommend and why? Assume 50% tax rate.

Answer 1

	Option 1	Option 2	Option 3
EBIT	1,00,000	1,00,000	1,00,000
Less : Interest	0	20,000	0
Income before taxes	1,00,000	80,000	1,00,000
Less : Taxes @50%	50,000	40,000	50,000
Income after taxes	50,000	40,000	50,000
Less : Preferred dividend	0	0	20,000
Income available to common stockholders	50,000	40,000	30,000
Number of shares outstanding	50,000	25,000	25,000
EPS = Income available to shareholders / Number of shares outstanding	=50000/50000	=40000/25000	=25000/25000
EPS	$                           1.00	$                                 1.60	$                               1.20
Interest in option2 =2,50,000*8% = 20,000
Preferred dividend in option3 =2,50,000*8% = 20,000
I would recommend option 2 as it has highest EPS of $1.60