Reference no: EM13374327

On 1 March 2013, Zentique Inc. reported its financial results, an extract of the 2012 balance sheet is shown below:

(in thousands of dollars)	Financial Structure
Liabilities
Current liabilities
Accounts payable	6,230,000
Short/current debt	0
Other current liabilities	3,069,000
Total current liabilities	9,299,000
Long-term debt	0
Other long-term liabilities	1,516,000
Long-term liabilities	1,516,000
Stockholder equity	14,532,000
Total	25,347,000

Moreover, the firm's 2012 income statement reported earnings of S3.496 billion with no interest expense:

(5 thousands)	2012	2011	2010
Earnings before interest and taxes	5,008,000	2,818,000	1,815,000
Interest expense	0	0	0
Income before tax	5,008,000	2,818,000	1,815,000
Income tax expense	(1 512 000)	(829,000)	(480,000)
Net income	3.496.000	1,989,000	1,335,000

If Zentique's management were considering he possibility of using debt financing for the first time, it might look at Hewlett-Packard Corporation (HPQ) as a benchmark firm for comparison purposes. HPQ used debt financing as shown on the following balance sheet and income statement:

Hewlett-Packard Corporation Balance Sheet 2012

(in thousands of dollars)	Financial Structure
Liabilities
Current liabilities
Accounts payable	25,822,000
Short/current debt	3,186,000
Other current liabilities	10,252,000
Total current liabilities	39,260,000
Long-term debt	4,997,000
Other long-term liabilities	5,916,000
Long-term liabilities	10,913,000
Stockholder equity	38,526,000
Total	88 699,000

Hewlett-Packard Corporation Income Statement

(5 thousands)	2012	2011	2010
Earnings before interest and taxes	9,466,000	7,440,000	3,759,000
Interest expense	(289,000)	(249,000)	(216,000)
Income before tax	9,177,000	7,191,000	3,543,000
Income tax expense	(1,913,000)	(933,000)	(1,145,000)
Net income	7,264,000	6,198,000	2,398,000

 

(a) Analyse the capital structure of I Icy. lot-Packard using both the debt ratio and interest-bearing debt ratio.

(b) Suppose Zentique has decided to change its capital structure by issuing debt financing and use the proceeds to repurchase some of its shares of stock from the open market. What fraction of the firm's 2.47 billion shares does the firm need to repurchase so as to achieve its interest bearing debt ratio equal to that of Hewlett-Packard for 2012?

If Zentique had carried out the above transaction at the start of 2012 by issuing bond with an 8% interest rate, analyse the effect of the above capital restructuring will have on its earnings per share.

(c) Assess the proposed change of capital structure for Zentique. Do you think it makes good financial sense? Why or why not?