Majong Corporation currently has 1,000,000 shares of common stock outstanding at a market price of $20 a share, and $20 million in 9% bonds. The company needs to raise $10 million in order to implement a series of investment projects. This amount can be raised by either (1) issuing 500,000 new shares of common at $20 a share, or (2) selling bonds with an 11% yield. If the firm’s tax rate is 30%, and the EBIT with the new projects is projected at $6 million, which alternative will result in the highest earnings per share?
Issue new shares = 1,500,000 total outstanding
EBIT = 6,000,000
Less interest 1,800,000
EBT 4,200,000
Tax 1,260,000
Earnings 2,940,000
EPS = 2,940,000/1,500,000 = $1.96
New debt = 10,000,000
Interest (10%) = 1,100,000
+ existing (8%)= 1,800,000
Total interest = 2,900,000
EBIT = 6,000,000
Less interest = 2,900,000
EBT = 3,100,000
Tax = 930,000
Earnings = 2,170,000
EPS = 2,170,000/1,000,000 = $2.17
