Question
Sohar Construction Company is currently a debt free company and is considering a buy-back of ordinary shares via an open market purchase, borrowing to do
Sohar Construction Company is currently a debt free company and is considering a buy-back of ordinary shares via an open market purchase, borrowing to do so. You have been commissioned to report on the likely impact of two alternative policies, depending on the level of sales and operating profit for its products. You are given the following information:
Level of sales
Weak Average Strong
PBIT /EBIT
Probability
RO 10 m 0.3 RO 100 m 0.4 RO 190 m 0.3
Equity is currently RO 200 million at book value. Tax is paid at 15 per cent. Two alternative share buy-back programmes are under consideration:
(i) Borrowing RO50 million at 5 per cent. (ii) Borrowing RO 100 million at 5.5 per cent.
Required (a) Calculate the current, and potential expected annual return on equity (ROE) under each programme. (16 Marks) (b) Calculate the expected value of Sohar Construction Company ROE under each scenario.
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