Equity and Debt slp Assignment Example | Topics and Well Written Essays - 750 words

Equity and Debt slp - Assignment ExampleHow this is important tummy be understood from the following example.While considering a small project needing investment of $10 one million million million, the family ABC has several alternatives beforehand. It has been forecast that the project is likely to generate operating profit of $3 million in a year excluding touch on charge against debt portion of the capital. The company has deuce alternatives to fund the requisite investment. The company may choose 100% equity elbow room all money will be provided by the partingholders. The company may issue 10 million shares to its shareholders each having a par honor of $1. In another alternative, the company may choose 50% equity and 50% debt to fund the investment. Debt is usable to the company at 10% interest rates to be paid annually. It will be fire to see how the earnings per share of the company are affected in both situations.It is amply out-of-doors from the above chart that b y incorporating debt to funding the project the firm has been able to enhance its earnings per share resulting into higher valuation in market place. By applying the same P/E multiple, the companys equity valuation is higher by 66% when the project is funded with the debt equity ratio of 11 instead of 100% equity.But this does not mean that debt can be raised to any level to enhance the company valuation. The higher the debt means the higher interest burden on the company. This also means that if the project is not able to pay its interest costs as usually happens in grueling recession then the project will be in jeopardy due to higher interest burden. This also means that project must choose an appropriate mix of debt and equity depending upon its profitability and diligence norms.Considering an investment project of $150m that is capable of generating 5m and 10m of operating profits before interest payments in its first two years of operations is likely to suffer from liquidity issues when it adopts its funding