Business is going well for Lazer Technology Ltd. The board of directors of this familyowned company believes that Lazer Technology Ltd could earn an additional $1,800,000 in profit before interest and taxes each year by expanding its range of products. However, the $4 million that the business needs for growth cannot be raised within the family. The directors, who strongly wish to retain family control of the business, must consider issuing shares to outsiders. They are considering two financing plans.
Plan A is to issue 100,000 ordinary shares at $40 each. Plan B is to borrow at 11% over five years. Interest is paid at the end of each year.
Lazer Technology Ltd presently has 500,000 ordinary shares issued. Both plans will raise the required $4 million. The company income tax rate is 30%.
Required: (1) Calculate the additional annual profit after interest and tax available to existing ordinary shareholders under each plan. (2) Analyse the advantages and disadvantages of both plans from the company’s viewpoint.