Question 14

1. Reca Ltd has an ordinary share capital of 400,000 shares fully paid to $1 and a 10% preference

share capital of 100,000 shares fully paid to $1. Additional funds of $600,000 are required for

expansion. The company is considering introducing some debt funds to its capital structure and

wants you to evaluate the effects on earnings per share of the following alternatives:

(a) Issue 600,000 fully paid ordinary shares for $1 each.

(b) Issue 300,000 fully paid ordinary shares for $1 each and $300,000 15% debentures.

(c) Issue $600,000 15% debentures.

Earnings before interest and taxes (EBIT) are expected to be $400,000, with a company tax rate of

30%.

2. Using all the information above, assume that the earnings before interest and taxes are distributed

with a standard deviation of $100,000 Calculate the coefficient of variation for alternatives (a) and

(c).