ALI Corp. realizes an income of Php 800,000 before interest and income taxes.

Its balance sheet shows:

Assets: Php 1,500,000

Liabilities: Php 200,000
Shareholder’s Equity : Php 1,300,000
There are 10,000 shares outstanding, par value of Php 100 per share. The company is evaluating a
project proposal requiring additional capital of Php 500,000 so as to increase its operating income by
Php 200,000.
Two alternative solutions have been presented:
1. Borrow Php 500,000 from a bank at 18%.
2. Issue additional 2,500 shares of capital stock at the market price of Php 200 per share.
Tax rate is 32%.
Compute for the Income after tax, EPS and ROE of each alternative. After which, decide which is a better
option. 25 pts

Alternative 1 Alternative 2
Income before the project Php 800,000 Php 800,000
After the project 200,00 200,000
Total 1,000,000 1,000,000
Less: interest expense 90,000 0
Income before tax 910,000 1,000,000
Tax (32%) 291,200 320,000
Income after tax 618,800 680,000

Earnings per share 618,800/10,000 680,000/12,500

Php 61.88 Php 54.40

Return on equity 618,800/1,300,000 680,000/1,800,000

47.60% 37.78%

Cost of Capital 18% (1-32%)

0.1224
12.24%

Interest rate (18%) 90,000

(500,000 x 32%)

Tax Benefit
 (90,000 x 32%) 28,800
Cost of Capital (amount) Php 61,200

Answer:

In concern with income after tax, the better alternative would be Alternative 2 since it is 61,200 higher
than of the 1st.

In concern with Earnings per share and return on equity, alternative 1 is the better option since it has
higher rate than the 2nd.

Overall, the better option would be alternative 1.