Bonotto Ltd: Financing Alternatives for Expansion - Debenture, Ordinary Shares, and Rights Issue

(a) ROCE = EBIT / Capital employed Capital employed = Non-current assets + Current assets - Current liabilities Capital employed = $2,500,000 + $925,000 - $600,500 = $2,824,500 EBIT = $1,150,000 ROCE = $1,150,000 / $2,824,500 = 40.7%

EPS = Earnings available to ordinary shareholders / Number of ordinary shares Number of ordinary shares = Ordinary share capital / Par value per share Number of ordinary shares = $80,000 / $4 = 20,000 EPS = $569,075 / 20,000 = $28.45

Debt-to-equity ratio = Total debt / Total equity Total debt = 10% debenture 2032 = $1,200,000 Total equity = Ordinary share capital + Other reserves = $80,000 + $1,544,500 = $1,624,500 Debt-to-equity ratio = $1,200,000 / $1,624,500 = 73.9%

(b) New EPS and debt-to-equity ratio under each financing alternative:

Debenture: New funds raised = $600,000,000 Interest expense = New funds raised x Coupon rate = $600,000,000 x 12% = $72,000,000 EBIT = Existing ROCE x New funds raised = 40.7% x $600,000,000 = $244,200,000 Tax expense = EBIT x Tax rate = $244,200,000 x 15% = $36,630,000 Net income = EBIT - Interest expense - Tax expense = $244,200,000 - $72,000,000 - $36,630,000 = $135,570,000 New number of ordinary shares = Number of existing shares = 20,000 New EPS = Net income / New number of ordinary shares = $135,570,000 / 20,000 = $6,778.50 New debt-to-equity ratio = Total debt / Total equity = ($1,200,000 + $600,000,000) / $1,624,500 = 37.0%

Ordinary shares: New funds raised = $600,000,000 / $40 = 15,000,000 shares New number of ordinary shares = Number of existing shares + New shares issued = 20,000 + 15,000,000 = 15,020,000 EBIT = Existing ROCE x New funds raised = 40.7% x $600,000,000 = $244,200,000 Tax expense = EBIT x Tax rate = $244,200,000 x 15% = $36,630,000 Net income = EBIT - Tax expense = $244,200,000 - $36,630,000 = $207,570,000 New EPS = Net income / New number of ordinary shares = $207,570,000 / 15,020,000 = $13.81 New debt-to-equity ratio = Total debt / Total equity = $1,200,000 / ($1,624,500 + $600,000,000) = 0.2%

1-for-4 rights issue: New number of ordinary shares = Number of existing shares x (1 + Rights ratio) = 20,000 x (1 + 1/4) = 25,000 New funds raised = Number of new shares issued x Issue price = 5,000 x $40 = $200,000 EBIT = Existing ROCE x New funds raised = 40.7% x $200,000 = $81,400 Tax expense = EBIT x Tax rate = $81,400 x 15% = $12,210 Net income = EBIT - Tax expense = $81,400 - $12,210 = $69,190 New EPS = Net income / New number of ordinary shares = $69,190 / 25,000 = $2.77 New debt-to-equity ratio = Total debt / Total equity = $1,200,000 / ($1,624,500 + $200,000) = 57.3%

(c) The debenture option has the lowest EPS but the lowest debt-to-equity ratio, while the ordinary shares option has the highest EPS but the lowest debt-to-equity ratio. The 1-for-4 rights issue has the lowest new funds raised and EPS, but a relatively high debt-to-equity ratio.

Based on the debt-to-equity ratio and EPS, the company should consider the ordinary shares option as it results in the highest EPS and the lowest debt-to-equity ratio. However, the company should also consider the potential dilution of existing shareholders' ownership and control through the issuance of a large number of new shares. The debenture option may be more suitable for the company if it wants to maintain control and ownership among existing shareholders, but it will result in a relatively high debt-to-equity ratio and interest expense. Ultimately, the company should carefully weigh the advantages and disadvantages of each financing option before making a final decision.