Question
The Ocean-Store Hypermarket is considering acquiring another of its regional competitor in Terengganu. The Ocean-Store plans to finance the purchase by the sale of common
The Ocean-Store Hypermarket is considering acquiring another of its regional competitor in Terengganu. The Ocean-Store plans to finance the purchase by the sale of common stocks or a debt issue. The company finance manager is required to evaluate how the two alternative financing plans will affect the earnings potential of the company. Total financing required is $20 million. The company tax rate is 40 percent. The companys current structure is as follows: $50,000,000 of 10% bonds (Par value $1,000 per unit) $10,000,000 shares of common stocks (par value of $1.00 per share) The company can arrange financing of the $20 million through Option A: 11 percent bond issue Option B: The sale of common stock at $10 per share a) Suppose Ocean-Store is confident of achieving an EBIT of $30 million, under which plan will shareholders get higher income? [Find EPS] b) What is the DFL for each plan at $30 million EBIT? c) If EBIT were to drop by 20%, what will be the drop in earnings under each plan? Explain your findings. [Hint: Find breakeven EBIT to explain]
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