3. Dundee Company has a total value of $74 million. Its stock sells at $32 a sha

Question

3. Dundee Company has a total value of $74 million. Its stock sells at $32 a share. At present, it has a loan of $10 million at 8% interest. It needs $3 million in additional capital. It can get the financing by selling 100,000 shares of stock at $30 (net) per share, or by borrowing the money at 8.5% interest. The expected EBIT after the new financing is $6 million, with a standard deviation of $3 million. Which method of financing will maximize its EPS? What is the probability that you have made the right choice?

Explanation / Answer

Borrowing the money at 8.5% interest will maximise EPS, Since Numerator(expected EBIT) in both alternatives are same and if Shares are issued than Denominator(No. of shares)wll increase, resulting lower EPS and if Money is Borrowed than, denminator will not increase and comparabily will Maximize its EPS.   

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