Look Before You Leverage

Group-2











The calculations show that if Symonds Electronics Inc. were to raise all of the required capital by issuing debt, its EPS would vary between $1.19 and $1.73 per share with the expected EPS being about $0.11 higher than the current EPS of $1.35. Likewise, the firm’s ROE could vary between 7.9% and 11.5%, with the most likely ROE being 9.7%.

   

   

 

     

 



 

I would recommend that the firm issue debt in order to raise the $5,000,000 for the expansion, since the firm currently has no debt and is not in any immediate risk of  bankruptcy. The expected EBIT is good and the firm’s value will increase with the inclusion of debt in the capital structure, due to the lower after-tax cost of debt.



 

Some of the issues to be concerned about when increasing leverage are: taxes and financial distress costs. The main advantage of issuing debt is the interest tax-shield. Unless the firm is capable of  earning sufficient profits to utilize the tax-shields it should not increase its debt ratio. Higher debt ratios can cause firms to experience financial distress during periods of low profitability. Firms with a greater risk of experiencing financial distress i.e. those whose profits vary considerably, should borrow less than firms with more stable revenues and profits





Thankyou….