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The Ocean-Store Hypermarket is considering acquiring another of its regional competitor in Terengganu. The Ocean-Store plans...

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Finance

The Ocean-Store Hypermarket is considering acquiring another ofits regional competitor in Terengganu. The Ocean-Store plans tofinance the purchase by the sale of common stocks or a debt issue.The company finance manager is required to evaluate how the twoalternative financing plans will affect the earnings potential ofthe company. Total financing required is $20 million. The companytax rate is 40 percent.
The company’s current structure is as follows:
$50,000,000 of 10% bonds (Par value $1,000 per unit)
$10,000,000 shares of common stocks (par value of $1.00 pershare)
The company can arrange financing of the $20 million through
Option A: 11 percent bond issue
Option B: The sale of common stock at $10 per share
a) Suppose Ocean-Store is confident of achieving an EBIT of $30million, under which plan will shareholders get higher income?[Find EPS]
b) What is the DFL for each plan at $30 million EBIT?
c) If EBIT were to drop by 20%, what will be the drop in earningsunder each plan? Explain your findings. [Hint: Find breakeven EBITto explain]

Answer & Explanation Solved by verified expert
3.6 Ratings (330 Votes)
a EBIT 30 million Existing Bond 50 million 10 Common stock 10 million at 1 ie 10 million shares Tax rate 40 or 040 i Option A 20 million bond 11 EPS Net income Outstanding shares Here Net income EBIT Interest 1 Tax rate Interest 50 million 10 20 million 11 Interest 5 million 220 million 720 million Net income 30 million 720 million1 040 Net income 2280 million 060 Net income 1368 million Now EPS 1368 million    See Answer
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The Ocean-Store Hypermarket is considering acquiring another ofits regional competitor in Terengganu. The Ocean-Store plans tofinance the purchase by the sale of common stocks or a debt issue.The company finance manager is required to evaluate how the twoalternative financing plans will affect the earnings potential ofthe company. Total financing required is $20 million. The companytax rate is 40 percent.The company’s current structure is as follows:$50,000,000 of 10% bonds (Par value $1,000 per unit)$10,000,000 shares of common stocks (par value of $1.00 pershare)The company can arrange financing of the $20 million throughOption A: 11 percent bond issueOption B: The sale of common stock at $10 per sharea) Suppose Ocean-Store is confident of achieving an EBIT of $30million, under which plan will shareholders get higher income?[Find EPS]b) What is the DFL for each plan at $30 million EBIT?c) If EBIT were to drop by 20%, what will be the drop in earningsunder each plan? Explain your findings. [Hint: Find breakeven EBITto explain]

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