Page 312 - AFM Integrated Workbook STUDENT S18-J19

Chapter 14

Greekus Co’s forecast after-tax profit for next year is $21.5 million, and its
current share price is $3.

Other information:

 Greekus Co pays tax at a rate of 20% per year and its after-tax return on
any new investment is estimated at 10%.

 The existing non-current liabilities are bonds with a coupon rate of 3%. A
covenant on these bonds states that the coupon rate should increase by
50 basis points if Greekus Co increases its gearing.

Required:

(a) Estimate the impact of the two proposals on next year’s forecast
earnings and forecast financial position.

(b) Evaluate the impact of the two proposals on the shareholders and
the bondholders of Greekus Co.

Solution

(a) Impact on SOFP and earnings

Earnings Current 1 2
$000 $000 $000

Forecast after-tax profit 21,500 21,500 21,500
Interest cost of new bonds (net of tax) (1,152) (1,152)
($36m × 4% × (1–0.20))
Interest cost of increased coupon rate (80)
(net of tax)
($20m × 0.5% × (1–0.20))
Extra return 10% on new investment 3,600
(10% × $36m)
––––––– ––––––– –––––––

Adjusted after-tax profit 21,500 23,868 20,268
––––––– ––––––– –––––––

Change +2,368 –1,232

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