FINANCIAL MANAGEMENT

EXERCISE 1
1 ADDITIONAL FUNDS NEEDED
SPAIN Corporation's sales are expected to increase from P 5,000,000 in 2012 to P 6,000,000 in 2012.
Its assets totaled to P 3,000,000 at the end of 2012. Spain has full capacity, so its assets must grow in
proportion to projected sales. At the end of 2012, current liabilities are P 1,000,000, ( P 200,000 of AP,
P 500,000 of notes payable and P 300,000 of accruals). The after tax profit margin is projected to be
10%. The forecasted payout ratio is 75%.

ADDITIONAL FUNDS NEEDED

REQUIRED: Determine the additional funds needed from external sources

SOLUTION:

Required increase in assets (1M x 3M/5M) 600,000

Increase in spontaneous liab ( 1M x [(20,000 + 30,000)/5M] -100,000
Increase in RE (6M x 10%) x (1-75%) -150,000
AFN 350,000

v    Key financial ratios:

ü Capital intensity ratio = Assets / Sales
ü After-tax profit margin = After-tax profit / Sales
ü Dividend pay-out ratio = Dividends/Earnings = Dividend per share / Earnings per share
ü Retention ratio = 100% - Dividend payout ratio

2 TARGETED CAPITAL STRUCTURE

Omega Company has the following capital structure
Debt, (16%) 750,000,000
Preferential share, (12.5%m P 100 par) 300,000,000
Ordinary share, (P 10 par) 1,000,000,000
Retained earnings 450,000,000
Total 2,500,000,000

Omega Company considers the following options for the financing of its planned expansion that
requires additional external financing for P 300,000,000

OPTION A
60% borrowing at 18%
The balance through the issuance of ordinary shares at P 15 per share

OPTION B
20% borrowing at 18%
15% preferential share at 12.5% to be issued at par
65% ordinary share to be sold at P 15 per share

Corporate tax rate is 35%

The project is likely to generate earnings before interest and taxes of P 230,000,000

REQUIRED: Between option A and B, which option shall be selected to achieve the higher EPS?

SOLUTION: OPTION A OPTION B

Profit before interest & tax 230,000,000 Profit before intere
Less: interest (750,000,000 x 16% + 180,000,000 x 18%) 152,400,000 Less: interest (750,
Profit before tax (230,000,000 - 152,400,000) 77,600,000 Profit before tax (2
Less: Tax (77,600,000 x 35%) 27,160,000 Less: Tax (99,200,0
Profit after tax (77,600,000 - 27,160,000) 50,440,000 Profit after tax (99
Less: Pref dividend (300,000,000 x 12.5%) 37,500,000 Less: Pref dividend
 Profit for equity (50,440,000 - 37,500,000) 12,940,000 Profit for equity (6
No. of equity share (1,000,000,000/10+300,000,000 x 40)/15 900,000,000 No. of equity share
EPS (12,940,000 / 900,000,000) 0.01437778 EPS (21,355,000 / 1

OPTION B is better
 OPTION B
Profit before interest & tax 230,000,000
Less: interest (750,000,000 x 16% + 60,000,000 x 18%) 130,800,000
Profit before tax (230,000,000 - 130,800,00) 99,200,00
Less: Tax (99,200,000 x 35%) 34,720,000
Profit after tax (99,200,000 - 34,720,000) 64,480,000
Less: Pref dividend (300,000,000 + 45,000,000x 12.5%) 43,125,000
Profit for equity (64,480,000 - 43,125,000) 21,355,000
No. of equity share (1,000,000,000/10+300,000,000 x 65)/15 1,400,000,000
EPS (21,355,000 / 1,400,000,000) 0.015253571