ABC Inc. was founded in 2013 and shareholders received 100,000 ordinary shares of a nominal value of €20 each. No other share issues have taken place until today (31.12.2021), and the share price has declined (today) at €10, mainly due to the COVID-19 crisis. At 1.1.2019, the company issued an 8-year €500,000 bond at par with 9% coupon rate. The company’s EBIT for 2021, was €120,000, and it is expected to remain stable in the coming years if the company does not expand. The company is currently assessing a new €600,00 investment project, which, if undertaken, is expected to increase EBIT by €40,000 per year. You are part of the CEO team, and you were assigned to assess the following two financing options for this project: Issue new shares at €10. Issue a new bond with 13% coupon rate. Assume that there are no issuance costs for either option and that the tax rate is 25%. Perform an EBIT-EPS analysis and answer the following questions: Would you invest in the new investment project? If yes, which financing option would you choose and why? Assume that the general economic perspectives improve so that the new shares can now be offered at €15 per share and the new bond will have a 11% coupon rate. Would this change your decision? Please explain. Based on A and B above, what are, in your opinion, the main factor(s) that influence the outcome of the EBIT-EPS analysis?

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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ABC Inc. was founded in 2013 and shareholders received 100,000 ordinary shares of a nominal value of €20 each. No other share issues have taken place until today (31.12.2021), and the share price has declined (today) at €10, mainly due to the COVID-19 crisis. At 1.1.2019, the company issued an 8-year €500,000 bond at par with 9% coupon rate. The company’s EBIT for 2021, was €120,000, and it is expected to remain stable in the coming years if the company does not expand. The company is currently assessing a new €600,00 investment project, which, if undertaken, is expected to increase EBIT by €40,000 per year. You are part of the CEO team, and you were assigned to assess the following two financing options for this project:

Issue new shares at €10.
Issue a new bond with 13% coupon rate. Assume that there are no issuance costs for either option and that the tax rate is 25%. Perform an EBIT-EPS analysis and answer the following questions:
Would you invest in the new investment project? If yes, which financing option would you choose and why?
Assume that the general economic perspectives improve so that the new shares can now be offered at €15 per share and the new bond will have a 11% coupon rate. Would this change your decision? Please explain.
Based on A and B above, what are, in your opinion, the main factor(s) that influence the outcome of the EBIT-EPS analysis?
Are there any disadvantages of the EBIT-EPS analysis? Please elaborate.

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