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Question 3 The company does not have any borrowings. Management forecast that revenue for FY 2016 will increase to $13.5million, while gross profit margin remain constant. Operating expenses will increase by 3% and corporate tax rate remain at 17%. Jack met up with the firm's bankers recently and understand that they are willing to extend a term loan of $10million to the company and the borrowing rate is 8%. The proceeds from this loan will be used for share repurchases. He want to evaluate the firm's optimal capital structure. Currently, there are 6 million ordinary share outstanding and each share is value at $5.00. a) Calculate the earnings per share for FY 2016 under the following scenarios: i) Without any borrowings ii) If the firm borrows $5million iii) if the firm borrows $10million Advise Jack which capital structure the firm should adopt and why. (15marks) b) Discuss whether the company can issue bonds to repurchase the shares advisable and whether use of earning per share as the criterion is appropriate in capital share structure decision. (10 marks) c) Generally, companies with high operating leverage will tend to have a high financial leverage. Critically analyse this statement. (10marks) Question 4 The company has been profitable in FY 2015 and the board is planning to declare dividends to its shareholders. They intend to declare a cash dividend of $2million at the forthcoming annual general meeting. However, the board is unsure whether this is an appropriate level of dividends to declare. Statement of Profit or loss Statement of financial position For year ended 31 Dec 2015 As at 31 Dec 2015 $'000 $'000 Revenue * 12,790 Current assets Cost of sales # (3,438) Cash and bank balances 3,534 Trade receivables 3,266 Gross profit Operating expenses Profit before income tax Income tax expenses Profit for the year 9,352 (1,456) Inventories 7,896 7,643 (1,357) 6,539 834 Non-current assets * all on credit term Plant and equipment 3,214 Total assets 10,857 # Beginning inventories is $702,000 Current liablities Trade payables Income tax payable 651 1,349 2,000 Capital and reserves Share capital 6,000 Retain earnings 2,857 Total liabilities and equity 10,857 a) Calculate the dividend pay-out ratio and the ex-dividend share price. (8marks) b) Shareholders of a company are eligible to receive dividends when declared while bondholders are eligible to receive interest payments which is mandatory. Based on this, shares are considered as riskier compared to bonds and the required rate of return on shares is higher than on bonds. However, in reality, bondholders face more risk than shareholders. Examine how this could arise and how the impact can be reduced. (10marks)