Which form of financing should be employed by the company

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Reference no: EM132831722

Question - A growing company is confronted with a choice between 15% debt issues and equity issues to finance its new investment. The firm's pre-expansion income statement is as follows:

Sales (production capacity of Rs 60,00,000 at current sales price) 45,00,000

Fixed cost 5,00,000

Variable cost (66 2/3%) 30,00,000

EBIT 10,00,000

Interest @ 12.5% 1,00,000

Earnings before taxes 9,00,000

Income tax @50% 4,50,000

Net income 4,50,000

Earnings per share (EPS) 9

The expansion programme is estimated to cost Rs 5,00,000. If this is financed through debt, the rate on new debt will be 15% and the P/E ratio will be 10 times. If expansion programme is financed through equity, new shares can be sold at Rs.100 per share and the P/E ratio will be 12 times. Expansion will generate additional sales of Rs.12,75,000. No additional fixed cost would be needed to meet the expansion operation. If the company is to follow a maximizing the market value of its shares, which form of financing should be employed by the company?

Reference no: EM132831722

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