Zybeck Corp.projects operating income of $4 million next year.The firm's income tax rate is 40%.Zybeck presently has 750,000 shares of ordinary shares,which have a market value of $10 per share,no preference shares,and no debt.The firm is considering two alternatives to finance a new product: (a)the issuance of $6 million of 10% bonds,or (b)the issuance of 60,000 new shares of ordinary shares.There are no issuance costs for either the bonds or the shares.If Zybeck issues ordinary shares this year,what will projected EPS be next year?

Question

Quizplus · Accepted Answer

If Zybeck issues 60,000 new shares of ordinary shares, the total number of shares outstanding will increase to 810,000.

The earnings available to ordinary shareholders will be operating income - interest on bonds (1-tax rate) / number of shares outstanding.

Option (a): Interest expense on $6 million of debt at 10% is $600,000 annually.

The earnings available to ordinary shareholders will be (4 million - 600,000(1-.40)) / 750,000 = $3.07 per share.

Option (b): By issuing 60,000 shares, the total number of shares outstanding will be 810,000.

The earnings available to ordinary shareholders will be (4 million(1-.40)) / 810,000 = $2.96 per share.

Therefore, the best choice for Zybeck Corp. is to issue 60,000 new shares of ordinary shares as it will result in the highest projected EPS for next year.