Reference no: EM133094094

Question - SBS company total asset is 1 million. It is financed by debt 30% and with equity 70%. The amount of equity is RM700,000. The current interest rate is 6% and the corporate tax rate is 30%. Currently the number of shares in the company is 350,000 units and it was issued at RM2 per share. The beta of the company is 1.04.

In the financial market, the risk-free rate is 3%. The risk free-rate is from a sample of I-year fixed deposit that is being offered by banks in the country. A majority of stock market analyst have agreed that the market should provide a return of 20%.

Within these conditions, the company has calculated that the weighted average cost of capital is 15.74%. The Earning per Share (EPS) of the company is RM0.46 from an Earnings before Interest and Tax (EBIT) of RM250,000. The economic value-added (EVA) of the company at the current level of EBIT is RMI 7,640. Other information that is available is the Time Interest Earned ratio of 9.02, the Debt Equity ratio of 0.43 and Debt Ratio of 0.3.

The Board of Directors (BOD) have assessed the situation and they were divided on their opinion of the company. The Executive Chairman wanted the company to operate using 100% equity. Some members of the board however, wanted to increase debt from the current debt of 30% to using 50% debt. Any increase in debt will be subjected to an interest rate of 8%. For both alternatives, SBS can issue ordinary shares at RM2 per share. The Executive Chairman and other Board Members both agree that EBIT can be increased to RM300,000.

Based on the above information prepare an analysis of the current situation and the alternative as suggested by the Executive Chairman and also from members of the Board. Show all your calculations and give your recommendations.