Answer to Question #88610 in Financial Math for shelin

Question

Sheen Ltd manufactures garden tools and has decided to expand operations. The new
operations are expected to increase EBIT from the current level of $500 000 to $1 million p.a.
Sheen has a capital structure that utilises bonds, ordinary equity and preference shares. The
$500 000 of issued bonds pay 6% p.a.. Preference shares pay an annual fixed dividend of $70
000. The company has 1 000 000 ordinary shares that are trading at $5.1 per share. The
Australian corporate tax rate is 30%. Most of the shareholders of Sheen live outside Australia
and cannot fully utilise dividend imputation credits.
Sheen needs to raise $700 000 to fund the expansion. Assuming the company can issue new
shares at the current market price, what is the impact on EPS new shares are issued to fund the
centre? If new debt can be raised at a 9% interest rate, what is the impact on EPS of using debt
rather than a new equity issue?

Answer 1

If the company can issue new shares at the current market price, then EPS will decrease as a result of new shares issued to fund the centre.

If new debt can be raised at a 9% interest rate, then EPS will decrease too, because using debt is comparatively more expensive rather than a new equity issue.