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Problem - Debt Financing versus Equity Financing
Donkey Ltd's equity is as follows:
Share capital $5,000,000
Retained earnings and reserves 2,000,000
Equity $7,000,000
Donkey Ltd plans to expand its operations by establishing a branch in Thailand. The new branch will cost $3.5 million. Expected profit before tax and interest when the new branch is operational is $2.2 million. The tax rate is 30%. Donkey Ltd is considering two financing alternatives:
1. Borrow $3.5 million at 8% interest.
2. Issue 100 000 $35 shares.
Required - Which funding alternative yields the higher return on equity? What other factors should be considered?
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