Business Finance

COLLEGE OF BUSINESS, HOSPITALITY AND TOURISM STUDIES

DEPARTMENT OF BANKING & FINANCE

FIN 601: CORPORATE FINANCE

TRIMESTER 2, 2013

TUTORIAL 3 QUESTIONS

1. Bushranger Building Limited (BBL) as no debt outstanding and a total market value of $80,000. Earnings before interest and taxes, EBIT, are projected to be $10,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 20% higher. If there is a recession, then EBIT will be 30% lower, BBL is considering a $40,000 debt issue with a 5% interest rate. The proceeds will be used to repurchase ordinary shares. There are currently 4,000 ordinary shares outstanding (issued). Ignore taxes for this problem.

a. Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued.

b. Repeat part (a) assuming BBL goes through with recapitalization. What do you observe?

2. Assume a corporate tax rate of 30%, recalculate parts (a) and (b) in Problem 1.

3. Dinkum Dampers Limited (DDL) is comparing two different capital structures: an all-equity plan (Plan I) and a levered plan (Plan II). Under plan I, DDL would have 600,000 shares outstanding. Under Plan II, there would be 300,000 shares outstanding and $10 million in debt outstanding. The interest rate on the debt is 10%, and there are no taxes.

a. If EBIT is $1.5 million, which plan will result in the higher EPS?

b. If EBIT is $11 million, which plan will result in the higher EPS?

c. What is the break-even EBIT?

4. Jumbuck Hotel Limited is comparing two different capital structures. Plan I would result in 1,000 shares and $30,000 in debt. Plan II would result in 2,000 shares and $15,000 debt. The interest rate on the debt is 10%.

a. Ignoring taxes compare both of these plans with an all-equity plan, assuming that EBIT will be $12,000. The all-equity plan would result in 3,000 shares outstanding. Which of the three...