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Chapter 3

Post project ratios – using debt finance:

Interest cover = $19m/$5.2m = 3.65 times

Earnings per share (EPS) = $9.7m/16m = 60.6 cents per share

Earnings yield = $0.606/$3.20 = 0.189, or 18.9%

Post project ratios – using equity finance:

Interest cover = $19m/$4m = 4.75 times

Earnings per share (EPS) = $10.5m/(16m + 8m) = 43.8 cents per share

Earnings yield = $0.438/$2.96 = 0.148, or 14.8%

(b) Debt financing option

If debt is used to fund the new project, the shareholders are likely to see
the change in EPS and earnings yield as positive.

The EPS increases from 48.1 cents per share to 60.6 cents per share,
and the earnings yield increases from 17.8% to 18.9%. This indicates
that Seed Co will potentially be able to pay out a higher dividend to the
shareholders in future.

On the other hand, the reduction in interest cover indicates that Seed Co
will face a higher level of risk if the debt financing option is used i.e. the
chance of Seed Co being unable to meet its interest obligations is higher.
The higher risk to shareholders could lead to a fall in the share price if
considered to be significant.

However, in practice it is unlikely that this issue will worry either the
shareholders or the lenders greatly, given that the movement in interest
cover is extremely small (3.75 to 3.65 times).

Overall, it is likely that both shareholders and lenders will be quite happy
with the EPS, earnings yield and interest cover ratios if the debt finance
option is used (assuming that the expected $4m increase in profit and
$8m NPV are achieved).

Equity finance option

The lenders will be happy if the rights issue goes ahead, because there
will be no additional interest payable and yet profits will increase, so the
interest cover ratio will rise significantly.

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