Financial Restructuring and Rights Issue Analysis

The Proposed Financial Restructuring

Use the following information to answer questions 1-4

BW plc’s finance director is considering a change in the company’s financing policy.  The company has always relied entirely on equity finance but it is now assessing the likely implications of a share buy back to be financed by a bond issue.  The company’s shares are trading at £4.00 and there are 25 million shares outstanding.  It is planned to buy back 5 million shares at the current market price and issue bonds for the same value and paying an interest rate of 6 per cent.  The company’s earnings before interest and tax is expected to remain at £20 million indefinitely into the future and the tax rate is 40 per cent. 

1. Consider the implications of the proposed re-structuring for the expected earnings per share and identify the value of EBIT at which the EPS will be the same following the re-structuring as it was for the all equity financed company.

1. £6 million
2. £12 million
3. £18 million
4. £24 million

2. Determine the company’s cost of capital prior to the proposed re-structuring.

1. 8 per cent
2. 12 per cent
3. 16 per cent
4. 20 per cent

3. Determine the company’s cost of capital prior to the proposed re-structuring.

1. 8 per cent
2. 12 per cent
3. 16 per cent
4. 20 per cent

4. In addition to the data above, assume that the rate of personal tax on income from equity investments is 20 per cent and the rate of personal tax on income from debt investments is 30 per cent.  Calculate the value of the geared firm after the proposed financial restructuring.  

102. 29
103. 29
104. 29
105. 29

Use the following information to answer questions 5-8

RG plc has decided to undertake a rights issue to raise £150 million.  The company’s shares are trading at £3.00 and it is proposed to make the rights issue at a discount of 25 per cent to this price. The company has 200 million shares outstanding.  Following the proposed rights offering the company is expected to report net income of £30 million per annum for the foreseeable future.  

5. Determine the exchange ratio of new shares for old under the terms of the proposed rights offer.

1. 1 for 2
2. 1 for 3
3. 1 for 4
4. 1 for 5

6. An investor holds 3000 shares in the company prior to the rights offer announcement.  She wishes to tail swallow (sell some rights to fund the purchase of new shares with zero additional investment in the company).  If the investor sells the required number of rights to achieve tail swallowing, how many shares can she take up in the rights offer?

1. 100 shares
2. 150 shares
3. 200 shares
4. 250 shares

7. Calculate the earnings per share and earnings yield for the company if it goes ahead with the rights offer.

1. 1125 and 0.0375 respectively
2. 1125 and 0.0400 respectively
3. 1500 and 0.0500 respectively
4. 1500 and 0.0625 respectively

8. The rights are traded in the market. One week after the announcement of the terms of the issue the share price has fallen to £2.50.  Determine the expected value of the theoretical ex-rights price at the end of the first week.

 

£2.14

£2.24

£2.34

£2.44

 

9. Which of the following statements is incorrect?

1. Deep discounted rights offers reduce earnings per share relative to rights offers made at smaller discounts.
2. Rights offers issued under a best efforts underwriting contract tend to be more risky than those underwritten through a firm commitment process.
3. Rights offers reduce the wealth of investors that choose not to take up their rights.
4. The stock price decline in response to a seasoned equity offer announcement is commonly interpreted as evidence of information asymmetry.

10. RG Plc is a takeover target for BW Plc, which operates in the same industry and can be treated as having identical operating risks to those faced by RG Plc.  RG Plc has a quoted equity beta of 2.5 and a market leverage ratio (debt-to-equity) of 1 for 1.  However, BW Plc operates with a debt to equity ratio of 1 to 3 and would expect to apply this capital structure to RG Plc following the takeover.  What would be the equity beta of RG following the acquisition by BW Plc?  The corporate tax rate is 30 per cent

1. 6137
2. 7137
3. 8137
4. 9137