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A company has stable earnings of S2 million and its shares are currently trading on a price earnings multiple {PIE) of 10 times. It has10 million shares in issue.
The company is raising S4 million debt finance to fund an expansion of its existing business which is forecast to increase annual earnings straight away by 25% and then remain at that level for the foreseeable future. The corporation tax rate is 20%. It is expected that the P/E will reduce to 8 times over the next year.
What is the most likely change in shareholder wealth resulting from this plan?
Suggested Answer: A, B, D
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34 comments · newest first
DE
Delmy
11 months ago
No change in shareholder wealth seems unlikely to me.
LA
Lai
11 months ago
The P/E dropping to 8 is a big factor here.
AL
Alaine
11 months ago
Wait, how does debt finance boost wealth? Sounds risky.
BI
Billy
12 months ago
I think it might actually be $4 million.
BO
Bobbye
12 months ago
Shareholder wealth will increase by $3.2 million.
AL
Aliza
1 year ago
I think the increase in earnings is straightforward, but I’m confused about how the tax rate and new P/E will ultimately affect the final answer.
SU
Sue
1 year ago
I feel like the P/E reduction will play a big role here, but I'm uncertain how to factor that into the overall change in shareholder wealth.
BR
Brittni
1 year ago
This question seems similar to one we practiced about debt financing and its impact on earnings. I think I need to calculate the new earnings first to see how it plays out.
EL
Elsa
1 year ago
I remember we discussed how to calculate the new earnings after the expansion, but I'm not sure how the P/E ratio affects shareholder wealth in this case.
GI
Gianna
1 year ago
This seems straightforward enough. The key is understanding how the debt financing, earnings increase, and P/E ratio change will all impact the share price and ultimately shareholder wealth. I think I've got a good handle on this.
NA
Nan
1 year ago
Alright, I've got a strategy here. First, I'll calculate the new earnings after the 25% increase. Then I'll apply the new P/E ratio to get the new share price. From there, I can determine the change in shareholder wealth.
CH
Cheryl
1 year ago
I'm a bit confused by the P/E ratio changes. How exactly does that factor into the shareholder wealth calculation? I'll need to review my notes on that.
KA
Kassandra
1 year ago
Okay, let's see. The company is raising debt to fund an expansion, which will increase earnings by 25%. But the P/E ratio is expected to drop. I think I need to do some calculations to determine the net effect.
SA
Santos
1 year ago
Hmm, this looks like a tricky one. I'll need to carefully work through the details to figure out the impact on shareholder wealth.
DY
Dyan
1 year ago
Hmm, I'm a bit confused on this one. I thought it might be the Develop stage, but I'm not totally certain. I'll have to review the IBM Garage Method stages again.
TA
Tamra
1 year ago
This seems pretty straightforward. I'll just need to navigate to the right page, select the appropriate options, and enter the required information. As long as I pay close attention to the details, I should be able to complete this task without any issues.
JA
Jamal
1 year ago
I remember a similar example where they talked about message integrity and signatures. I think this situation relates to that, emphasizing how important it is to verify.
AS
Ashley
1 year ago
Hmm, I wonder if the company will use the new debt to invest in a time machine and go back to when P/E ratios were higher. That would really boost shareholder wealth!
MO
Monroe
1 year ago
I bet the exam writers are just trying to trick us with all these numbers. I'm going with D - no change in shareholder wealth. That's the most boring but probably correct answer.
FL
Fletcher
1 year ago
I guess we'll just have to wait and see what the correct answer is.
MA
Martin
1 year ago
That's true, but the decrease in P/E ratio might offset that potential increase.
DI
Dino
1 year ago
But what if the increase in earnings actually leads to an increase in shareholder wealth?
EM
Emile
1 year ago
I think you might be right, D does seem like the safest option.
YE
Yesenia
1 year ago
Aha! The question is asking for the 'most likely' change, so I think C is the best answer. Gotta love those 25% earnings boosts!
AL
Alease
1 year ago
True, but overall it still seems like a positive move for shareholder wealth with that earnings boost.
SA
Sabrina
1 year ago
But don't forget about the decrease in P/E ratio to 8 times next year, that might affect shareholder wealth.
BL
Blossom
1 year ago
I agree, C seems like the most likely answer with that 25% increase in earnings.
BR
Brice
2 years ago
Wait, does the reduction in P/E ratio cancel out the earnings increase? I'm not sure, this is tricky. Maybe option D is the safest choice.
NA
Nadine
1 year ago
Yes, it might not cancel out the earnings increase completely, but it could still affect the overall wealth.
MA
Marjory
1 year ago
I think the reduction in P/E ratio will have an impact on shareholder wealth.
AL
Alethea
2 years ago
I agree with Candida, the shareholder wealth will increase by $4 million because of the expansion and increase in earnings.
LO
Loren
2 years ago
I disagree, I believe the shareholder wealth will increase by $3.2 million.
AD
Adolph
2 years ago
Hmm, this seems straightforward. The increased earnings should boost the share price, resulting in greater shareholder wealth. I'm leaning towards option B.
CA
Candida
2 years ago
I think the shareholder wealth will increase by $4 million.