Question 4

ABC firm approached you for advice and presented the following information to you.

1. As the financial analyst, kindly give your opinion on the advatanges of debt utilisation under the various scenarios using Earnings Per Share (EPS), Return on Equity (ROE). Carefully interprete your results comparing the performance of these indicators under the current situation without debt and the proposed situation (with debt) using various scenarios.
2. How do the Pecking Order Theory and the Trade-off Theory explain capital structure choices in Ghana?

SITUATION Firm ABC Current Proposed $8,000,000 Assets $8,000,000 Debt 0 4,000,000 4,000,000 Equity 8,000,000 Debt/Equity Ratio o Share Price $20 1 $20 400,000 200,000 Shares Outstanding Interest rate 10% 10% BAD TIMES $500,000 0 $500,000 POSSIBLE OUTCOMES Current situation - no debt NORMAL TIMES GOOD TIMES EBIT $1,000,000 1,500,000 Interest 0 o Net Income 1,000,000 1,500,000 EPS ROE Proposed: debt = 50% of TA EBIT 1,000,000 1,500,000 Interest 400,000 400,000 Net Income 600,000 1,100,000 EPS ROE 500,000 400,000 100,000 SITUATION Firm ABC Current Proposed $8,000,000 Assets $8,000,000 Debt 0 4,000,000 4,000,000 Equity 8,000,000 Debt/Equity Ratio o Share Price $20 1 $20 400,000 200,000 Shares Outstanding Interest rate 10% 10% BAD TIMES $500,000 0 $500,000 POSSIBLE OUTCOMES Current situation - no debt NORMAL TIMES GOOD TIMES EBIT $1,000,000 1,500,000 Interest 0 o Net Income 1,000,000 1,500,000 EPS ROE Proposed: debt = 50% of TA EBIT 1,000,000 1,500,000 Interest 400,000 400,000 Net Income 600,000 1,100,000 EPS ROE 500,000 400,000 100,000