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

These will cost £20 million and will reduce operating costs by £6 million a year for their estimated useful life of 10 years starting next year (Year 10). To finance this scheme, the business can raise £20 million either:

1 by the issue of 20 million ordinary shares at 100p; or 2 by loan capital at 14 per cent interest a year, capital repayments of £3 million a year commencing at the end of Year 11.

Extracts from Telford Engineers’ financial statements appear below:

Summary of balance sheet at 31 December Year 6 Year 7 Year 8 Year 9

£m £m £m £m Non-current assets 48 51 65 64 Current assets 55 67 57 55 Current liabilities Trade payables (20) (27) (25) (18)

Bank overdraft (5) – (6) (8)

78 91 91 93 Equity 48 61 61 63 Non-current liabilities 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 income statements for years ended 31 December Year 6 Year 7 Year 8 Year 9

£m £m £m £m Sales revenue 152 170 110 145 Profit before interest and taxation 28 40 7 15 Interest payable (4) (3) (4) (5)

Profit before taxation 24 37 3 10 Taxation (12) (16) (0) (4)

Profit after taxation 12 21 3 6 Dividends paid (6) (8) (3) (4)

Retained profit 6 13 0 2 For your answer you should assume that the corporate tax rate for Year 10 is 30 per cent, that sales revenue 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 Year 10 as in Year 9.
Required:

(a) Prepare, for each financing arrangement, Telford Engineers’ projected income statement for the year ending 31 December Year 10 and a statement of its share capital, reserves and loans on that date.

(b) Calculate Telford’s projected earnings per share for Year 10 for both schemes.

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