FIN309 – MA Template

Subject: Business    / Finance
MA Template

Currently, Nakami does not have any borrowings. Management forecast that revenue for FY 2016 will increase to $13.5 million, while gross profit margin remains constant. Operating expenses will increase by 3% and corporate tax rate remains at 17%.

Sharon met up with the firm’s bankers recently and understand that they are willing to extend a term loan of $10 million to Nakami and the borrowing rate is 8%. The proceeds from this loan will be used for share repurchase.

She wants to evaluate the firm’s optimal capital structure. Currently, there are 6 million ordinary share outstanding and each share is valued at $5.00.

(a) Calculate the earnings per share for FY 2016 under the following scenarios:

(i) Without any borrowings
(ii) If the firm borrows $5 million
(iii) If the firm borrows $10 million

Advise Sharon which capital structure the firm should adopt and why.

(b) Discuss whether the company can issue bonds to repurchase the shares advisable and whether use of earnings per share as the criterion is appropriate in capital structure decision. (6 marks)
(c) Generally, companies with high operating leverage will tend to have a high financial leverage. Critically analyse this statement. (8 marks)