Telford Engineers pic, a medium-sized Midlands manufacturer of automobile components, has decided to modernise its factory by introducing a number of robots.

These will cost £20 m and will reduce operating costs by £6 m per year for their estimated useful life of ten years. To finance this scheme the company can either:

1 Raise £20 million by the issue of 20 million ordinary shares at lOOp.

2 Raise £20 million debt at 14 per cent interest per year, capital repayments of £3 million per year commencing at the end of 19X9.

Extracts from Telford Engineers’ accounts appear below:

For your answer you should assume that the corporate tax rate for 19X7 is 40 per cent, that sales and operating profit will be unchanged except for the £6 million cost-saving arising from the introduction of the robots and that Telford Engineers will pay the same dividend per share in 19X7 as in 19X6.

(a) Prepare for each scheme, Telford Engineers’ profit and loss account for the year ended 31 December 19X7 and a statement of its share capital, reserves and loans on that date.

(b) Calculate Telford’s earnings per share for 19X7 for both schemes.

(c) Calculate the level of earnings (profit) before interest and tax at which the earnings per share for each scheme is equal.

(d) Which scheme would you advise the company to adopt? You should give your reasons and state what additional information you would require.

Transcribed Image Text:

Summary of balance sheet at 31 December 19X3 19X4 19X5 19X6 (estimated) m m Fixed assets 48 51 Current assets 55 67 m m 65 64 57 55 Less: Amounts due in under one year Creditors (20) (27) (25) (18) Overdraft (5) (6) (8) 78 91 91 93 Share capital and reserves 48 61 61 63 Loans 30 30 30 30 78 91 91 93 Number of issued 25p shares 80 million 80 million 80 million 80 million Share price 150p 200p 100p 145p Summary of profit and loss accounts for years ended 31 December 19X3 19X4 19X5 19X6 (estimated)