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Subject 3 (30%) Orion is a small company listed in the stock market that until now is funded exclusively by common equity. You recently had
Subject 3 (30%) Orion is a small company listed in the stock market that until now is funded exclusively by common equity. You recently had a meeting with the financial director where you discussed the possibility of using other financing sources than common equity. He then invited you to take some time and work on this case, Orion's data is as follows: 1. The total value of the company today is 5,000,000. 2. The company may obtain long-term loans at the rate of 8%. 3. The company may issue preferred shares with a compulsory dividend of 10% of their value 4. The company may issue common shares at a price of 2.5 per share. 5. The company's annual earnings before interest and taxes are expected to be 600,000 6. The corporate tax rate is 20%. You have thought of presenting the following three possible financing plans (according to which 5,000,000 are allocated): Plans Preferred Stock Debt 20% 40% 50% 20% 30% Common Equity 80% 40% 20% Answer the following questions. a. You would like to make a brief introduction to the theory of capital structure and present it to the financial manager. Briefly refer to the various theories mentioned in this field (approximately 500 words). (10%) b. Calculate the earnings per share (EPS) that correspond to each of the three (3) plans. Which of the three alternative plans would you suggest according to the data available to you, using the EBIT-EPS analysis to support your answer? (10%) c. Diagrammatically investigate the relationship between Earnings before interest and taxes (EBIT) and Earnings per Share (EPS) for the three alternative plans and comment on the conclusions drawn from the chart. Discuss which plan is preferable at the different EBIT levels? (10%)
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