Question
Financial leverage and the company value. The value of the company's total assets is USD20 million. The company is financed 50% with liabilities and 50%
Financial leverage and the company value.
The value of the company's total assets is USD20 million. The company is financed 50% with liabilities and 50% with equity. The interest rate on liabilities is 10% and the value of the ratio"book value per share" is 20 USD. The income tax is 19%. The Management Board is analyzing two strategies aimed at increasing the value of assets by USD30 million.
I. Capital would be obtained by issuing shares at the price of USD20, as well as additional liabilities, while the relation between the value of liabilities and the value of the company's assets would not change. The new commitments would require 12% interest payments annually.
II. Capital would only be obtained through the issue of new shares at an issue price of USD20 and the entity's fixed costs of USD200,000.
a. If the overall ROA (EBIT / Total assets) is 12%, calculate the net profit per share before deciding to change the strategy;
b. What is the level of leverage in the implementation of each strategy and without the implementation of the strategy;
c. If the company's shares could be sold for USD40 each, what impact would it have on the earnings per share resulting from the application of strategy I and strategy II.
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