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Goodshape Company has currently, an ordinary share capital of Rs. 2.5 million, consisting of 25,000 shares of Rs. 100 each. The management is planning to raise another Rs. 2 million to finance major program of expansion through one of the four possible financing plans. The plans are:
i. Entirely through ordinary shares.
ii. Rs. 1 million through ordinary shares and Rs. 1 million through long-term borrowing at 8 percent interest per annum.
iii. Rs. 0.5 million through ordinary shares and Rs. 1.5 million through long-term borrowing at 9% interest per annum.
iv. Rs. 1 million through ordinary shares and Rs. 1 million through preference shares with 5 percent dividend.
The company's expected Earnings Before Interest and Taxes (EBIT) will be Rs. 0.8 million.
Required:
Consider a corporate tax rate of 50%, determine the earnings per share (EPS) in each alternative and comment on the implications of financial leverage.
Which type of financing is appropriate to each firm?
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