- 8 Marks
FM – L2 – Q31 – Sources of finance: debt
Question
A company has the following equity shares and bonds in issue:
2,000,000 equity shares of GH¢0.50 each.
GH¢1,000,000 of 4% convertible bonds.
The current earnings per share (EPS) is GH¢0.25.
The rate of tax is 30%.
The convertible bonds are convertible into equity shares at the rate of 40 shares for every GH¢100 of bonds.
Required
On the basis of this information, calculate the expected change in EPS if all the bonds are converted into equity shares.
Answer
Earnings = profit after interest and tax.
Current total annual earnings (2,000,000 × GH¢0.25) = GH¢500,000
On conversion:
Reduction in interest cost (GH¢1,000,000 × 4%) = 40,000
Minus increase in taxation (30%) = (12,000)
Increase in annual earnings = 28,000
Total annual earnings after conversion = 528,000
Shares currently in issue = 2,000,000
New shares issued on conversion (GH¢1,000,000 / GH¢100 × 40 shares) = 400,000
Total shares after conversion = 2,400,000
EPS after conversion = GH¢528,000 / 2,400,000 shares = GH¢0.22 per share.
There will be dilution in EPS from GH¢0.25 to GH¢0.22 per share.
- Topic: Sources of finance: debt
- Uploader: Samuel Duah