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PBIT vs. EPS Financing Options Analysis

- Divya Electronics is considering raising 200 crores for an expansion project that will generate annual revenues of 240 crores. It has two options: issue a public offering of shares at 106 rupees per share or privately place debentures carrying 8% interest. - The indifference point between the options, where earnings per share would be equal, is a PBIT of 148 crores. Above this level, debt financing would be preferable. - Assuming full operation of the expansion, debt financing would result in an EPS of 7.5 rupees compared to 7.2625 rupees for equity financing. - Debt financing would increase the degree of total leverage from 2.5 to 2

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Venkat Thiagarajan
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19 views2 pages

PBIT vs. EPS Financing Options Analysis

- Divya Electronics is considering raising 200 crores for an expansion project that will generate annual revenues of 240 crores. It has two options: issue a public offering of shares at 106 rupees per share or privately place debentures carrying 8% interest. - The indifference point between the options, where earnings per share would be equal, is a PBIT of 148 crores. Above this level, debt financing would be preferable. - Assuming full operation of the expansion, debt financing would result in an EPS of 7.5 rupees compared to 7.2625 rupees for equity financing. - Debt financing would increase the degree of total leverage from 2.5 to 2

Uploaded by

Venkat Thiagarajan
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Table 1

Case study Key highlights:

• Divya Electronics was promoted 20 years by Dipankar Mitra

• The firm employed debt equity ratio of 1.5:1

• The firm was reasonably profitable

• Firm issued bonus on two occasions. One before debuting IPO and one after IPO

• Current market price per share is Rs115 giving PE ratio of 16.43

• Dipankar hold around 4.5 crores of shares

Expansion of firm

• It will require Rs 200 cr which is supported by external financing

• Projected to generate annual revenue of Rs 240 cr

• Variable cost is 60% of revenue and fixed operating cost would be Rs 50 cr

Options available for Divya Electronics


• It can make public equity of shares at Rs 106. The issue expenses will be Rs 6 per share

• It can privately place debentures carrying interest rates of 8%

Balance Sheet

Sources of funds In crores

Equity capital 140

Reserves and surplus 250

Loan funds 200

Total 600

Application of Funds In crores

Net fixed asset 400

Net current asset 200

Total 600

Profit and Loss Account

Particulars In crores

Revenues 800

Variable cost 480

Contribution Margin 320

Fixed Operating cost 180

PBIT 140

Interest 20

PBT 120

Tax 36

PAT 84

A) Compute the EPA-PBIT indifference point for the two financing options

EPS - Option 1 = ( PBIT - I )( 1 - t ) / n

= ( PBIT - 20 ) ( 1 - 0.3 ) / 16

EPS - Option 1 = ( PBIT - I )( 1 - t ) / n

= ( PBIT - 20 ) ( 1 - 0.3 ) / 14

Equating both options we get PBIT = Rs 148 crore

Rs 148 Crore is the indifference point.

Interpretations

• When PBIT < Rs 148 crore, option 1 of equity is better

1
• When PBIT < Rs 148 crore, option 1 of equity is better

• When PBIT > Rs 148 Crore, option 2 debt is better

• When PBIT = Rs 148 crore, both options are better

B ) Calculate the EPS for the following year under two financing options assuming that the expansion project would be fully operational

Particulars Option 1 Option 2

Revenue 1040 1040

Variable cost 625 624

Contribution Margin 416 416


Fixed Operating cost 230 230
PBIT 186 186
Interest 20 36
PBT 166 150
Tax 49.8 45
PAT 116.2 105
EPS
Since the PBIT (186) is greater than Rs 148 Cr, 7.2625 7.5alternative

the option 2 is the best

EPS of option 2 is 7.5

C) Show how the degree of total leverage will change under the two financing options

DTO = Contribution / EBT

DTL (Option 1) = 416 / 166 = 2.5

DTL (Option 2) = 416 / 150 = 2.77

D) Highlight other issues that you believe are important for taking the decision

Interest coverage ratio = PBIT / Interest on debt

For option 1 = 186/20 = 9.3 : 1

For option 2 = 186/36 = 5.1 : 1

Lower the ratio more the company is burdened by debt expenses. So we conclude that option 1 is better than option 2 as its interest coverage
ratio is more.

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