Impact of Capital Structure on Earnings Per Share

This assignment examines the relationship between corporate finance and earnings per share (EPS). A case study is presented where Sheen Ltd raises additional funds for business expansion, resulting in a decrease in EPS. The analysis focuses on the importance of capital structure in maintaining or improving EPS values.

Introduction to Corporate
Finance

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
MAIN BODY...................................................................................................................................1
Question 1. Explaining:...............................................................................................................1
a. .................................................................................................................................................1
b. .................................................................................................................................................1
c. .................................................................................................................................................2
d. .................................................................................................................................................4
e. .................................................................................................................................................4
Question 2. Coca- Cola Amatil...................................................................................................4
1...................................................................................................................................................4
2...................................................................................................................................................4
3...................................................................................................................................................5
4...................................................................................................................................................6
5...................................................................................................................................................6
Question 3. Sheen Ltd.................................................................................................................6
1. Existing capital........................................................................................................................6
2. Issue new capital.....................................................................................................................7
CONCLUSION................................................................................................................................8
REFERENCES................................................................................................................................9

INTRODUCTION
Corporate finance is concerned with the sources of funding for company which helps in
dealing with the financial and investment decisions making process. It is associated with the
long-term and short-term financial planning, strategies and plans and their successful
implementation. The report will discuss about the concept of Initial investment, Net present
value and present value which helps in selecting the best project. Further, focus will be made on
calculation and interpretation of annual dividend growth rate of Coca- Cola Amatil. At last, EPS
is calculated for Sheen Ltd by considering new issue.
MAIN BODY
Question 1. Explaining:
a.
1. Leasing of the land as it is
2. Constructing own house
3. Constructing a dormitory for the students of USP and giving it on rental basis to those
USP students.
b.
Initial investment is the amount which is required for starting the business operations or a
project. The amount of initial investment required for each project are as follows:
1. Leasing of the land as it is – For starting a leasing business, individual already has
acquire a piece of land and get itself registered under his/her name as per the procedures.
The amount of initial investment depends on the size, type and area in which land is
being purchased. For this project, $50 000 is considered as the initial investment amount.
2. Constructing own house – For constructing an own house, individual should have
enough cash balance to get the construction operations complete. Before starting
construction process, individual should purchase a piece of land in which initial
investment of $15 00 000 is taken into consideration.
3. Constructing a dormitory for the students of USP and giving it on rental basis to
those USP students – For building a dormitory section with the objective of student’s
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rental, the owner having big size land on which premises will be constructed will require
an initial investment of around $80 000 is required for making registration.
c.
The relevant cash flow for each project are as follows:
1. Leasing of the land as it is – Dealing in property business is considered as one of the
most profit earning business nowadays. The land allotted on lease for a period of 6 years
will generate cash flow in form of lease rent of value $125 000 monthly. Taking interest
rate of 12%, Calculating Net present value
Year Project Discount @
12%
Discounted
Cash flows
of project
1 125000 0.893 111607.14
2 125000 0.797 99649.23
3 125000 0.712 88972.53
4 125000 0.636 79439.76
5 125000 0.567 70928.36
6 125000 0.507 63328.89
Total discounted cash
flow 513925.92
less: Initial investment 50000
Net present value 463925.92
2. Constructing own house – In construction of house, cash flow in form of maintenance
cost, renovation, repairing etc. related expenses will be incurred. After completing
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construction of house, it will be used for staying purpose. In living in own house, an
amount of $25000 will be saved which is required in case of rented house.
By taking interest rate of 12%, Calculating Net present value
Year Project Discount @
12%
Discounted Cash
flows of project
1 25000 0.893 22321.43
2 25000 0.797 19929.85
3 25000 0.712 17794.51
4 25000 0.636 15887.95
5 25000 0.567 14185.67
Total discounted cash flow 90119.41
less: Initial investment 1500000
Net present value -1409880.59
3. Constructing a dormitory for the students of USP and giving it on rental basis to
those USP students – For carrying on construction of a dormitory, the initial investment
of around $18 00 000 is required. The cash flow in this case will be, $500 000 as the
amount of rent that will receive by owner each month from the students for the next 8
years’ time period. Also, the owner has to estimate and incur expense related to the
maintenance of premises infrastructure.
Let take interest rate of 12%, Calculating Net present value
Year Project Discount @
12%
Discounted Cash
flows of project
1 500000 0.893 446428.57
2 500000 0.797 398596.94
3 500000 0.712 355890.12
4 500000 0.636 317759.04
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5 500000 0.567 283713.43
6 500000 0.507 253315.56
7 500000 0.452 226174.61
8 500000 0.404 201941.61
Total discounted cash flow 2483819.88
less: Initial investment 80000
Net present value 2403819.88
d.
On the basis of Net present value calculation, the project ranked on top priority is
dormitory premise construction for USP students with Net Present Value of $2403819.88.
Whereas, on second rank the project of leasing of the land in the same form is placed with Net
Present Value of $463925.92. At last constructing own house is ranked on the last place because
of low Net present value of $-1409880.59.
e.
As per the net present value calculated, the best project to be taken into consideration is
undertaking of construction of a dormitory for the students of USP and giving it on rental basis
to those USP students. It is because it is having high Net present value as compared to other
business projects.
Question 2. Coca- Cola Amatil
1.
Annual dividend growth for CCA within 2013 to 2017 is enumerated below:
Particulars / Years 2012 2013 2014 2015 2016 2017
Dividend per share 32 32 42 43.5 46 47
Growth rate (in %) - 0% 31% 4% 6% 2%
(Source: Annual report of Coca-Cola Amatil (2013). n.d.)
(Source: Annual report of Coca-Cola Amatil (2015). n.d.)
(Source: Annual report of Coca-Cola Amatil (2017). n.d.)
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2.
By doing assessment, it has found that CCA will not maintain recent growth in dividend.
Moreover, as per the theoretical framework maximization of shareholder’s wealth is one of the
main motive of firm. Thus, for maintaining the trust and belief of shareholders business unit is
required to offer optimal dividend to the shareholders. As per the above depicted tabular
presentation fluctuated trend has been assessed in dividend’s growth rate. Hence, for attracting
more shareholders and maintaining the trust of existing one company needs to lay focus on
providing shareholders with suitable returns. Hence, growth range in relation to dividend should
be between 6 to 10% or as per industry standards.
3.
Value of stock = D1 / (k - g)
K = required rate of return
G: Dividend growth rate
D1: Dividend per share pertaining to upcoming year
Given that:
Particulars Figures
K 10%
G 5%
Intrinsic value of CCA’s share at 31st
December 2018 n
29.09 +27.77 + 26.51 + 25.30 + 24.15 +
460.68
= $593.5
Working note:
Years Dividend
Growth
rate
Dividend
s as per
growth
rate
PV value
@10%
Discounted
dividend
value
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2013 32 32 0.909 29.09
2014 32 5% 33.6 0.826 27.77
2015 33.6 5% 35.28 0.751 26.51
2016 35.28 5% 37.04 0.683 25.30
2017 37.04 5% 38.90 0.621 24.15
2018 38.90 5% 40.84 0.564 23.05
40.84 / (.10-0.05)
= 40.84 / .05
=816.8
816.8 * .564
=$460.68
4.
Date Open High Low Close
Adj
Close Volume
12/31/2019 6 6.03 5.81 5.99 5.730433 23400
(Source: Coca-Cola Amatil Ltd, 2019)
5.
By taking into account book value and stock price, investors are advised to avoid making
investment in the shares which are traded at lower price. In other words, at the end of December
2018, share price was $5.73, whereas book value accounts for high figure. Referring this,
investors should focus on money in the shares of firm whose intrinsic and actual value is near5 to
each other.
Question 3. Sheen Ltd.
On the basis of given case scenario, present capital structure of Sheen Ltd comprises debt
bonds, ordinary equity and preference shares. Now, the company is having following capital
structure:
Particulars Figures
6% Bonds $500000
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Annually fixed dividend on preference shares $70 000
Number of ordinary shares 1,000,000
Current market price of ordinary shares $5.1
corporate Tax rate 30%
1. Existing capital
When capital structure of company is having 10 00 000 ordinary shares of $5.1
per share, $500 000 issued bonds pay 6% p.a. And Preference shares dividend
of $70 000 with corporate tax @ 30%
Particular Amount in $ Amount in $
EBIT 500000 1000000
Less Interest 30000 30000
(500000 bonds @ 6% p.a.)
EBT 470000 970000
Less Tax @ 30% 141000 291000
EAT 329000 679000
Less Preference Dividend 70000 70000
Amount Available for equity
shares 259000 609000
Number of Equity Shares 1000000 1000000
EPS = Amount available for
equity shares / Number of
ordinary shares on issue
0.259 0.609
Interpretation:
The Sheen Ltd is having equity share of 1000000 with market price of $5.1 per share, the earning
per share at EBIT level of $500 000 is $0.259 per share and at EBIT level $1 million is
$0.609 per share. From this it can be interpreted that as the profit margin of company
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increases, it also leads to increase in the value of shareholders wealth. When profit
margin increase for company it has to pay more tax.
2. Issue new capital
When Sheen Ltd is expanding its capital structure by raising $700 000 by
making issue of new shares at the current market price of $5.1 per share, new
debt bonds issued @ 9% p.a. and corporate tax of 30%.
Particular Amount in $ Amount in $
EBIT 500000 1000000
Less Interest 63000 63000
(700000 bonds @ 9% p.a.)
EBT 437000 937000
Less Tax @ 30% 131100 281100
EAT 305900 655900
Less Preference Dividend 70000 70000
Amount Available for equity
shares 235900 585900
Number of Equity Shares 1137255 1137255
EPS = Amount available for
equity shares / Number of
ordinary shares on issue
0.207 0.515
Interpretation:
In this case scenario, company is raising $700 000 more funds for meeting its business
expansion expenses. The company has make issue at the current market price of $5.1 per share.
With the issue of new shares of 137255 (i.e. $700000 divided by $5.1 per share), the earning per
share has decreased as compared to previous capital structure mix. The earning per share at EBIT
level of $500 000 is $0.207 per share and at EBIT level $1 million is $0.515 per share.
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From the above case, it can be concluded that if Sheen Ltd is raising more funds for
meeting the expansion expenses of business, it is creating a negative impact on the earning per
share value. The earning per share is an indicator of company's profitability, the higher the EPS
value, better will the productivity of the company. The company should focus on improving its
capital structure either by making repurchase of its shares from the market or by taking help of
corporate restructuring concept.
CONCLUSION
From the above report it can be concluded that corporate finance is considered as the
blood of every business organisation. With the help of proper allocation and utilisation of
financial resources, business can achieve its business goals and objectives.
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