Reference no: EM132554081

Dell Ltd has no debt outstanding, and currently has a market value of $125 million. There are three possible scenarios for the next year:

Economic condition       Earnings before interest and tax (EBIT)

Strong                              $15 million

Normal                                $10 million

Weak                                   $5 million

The company is considering issuing $50m of debt with 5% interest rate. Dell will use the money raised through the debt issuance to repurchase the ordinary shares. There are currently 10 million shares outstanding.

PART A :

Question 1: Assume no tax, what are the possible outcomes for earnings per share (EPS) next year before the debt is issued? Assume Dell has issued the debt and repurchased the shares, calculate (a) again. What do you observe?

PART B:

Question 2: You have a brilliant business idea which potentially can create the next 'Facebook'. However, the initial investment amount is way beyond what you can afford. What would be your financing strategy to kick start the new business?

PART C:

Question 3: Short-term debt financing usually attracts lower interest rate. However, it is common to observe businesses finance with long-term debt. Is such behaviour irrational? Explain.