Analysis of Financial Restructuring and Rights Issues

Analysis of Financial Restructuring and Rights Issues

Question

The Proposed Financial Restructuring

Use the following information to answer questions 1-4

BW plc’s financial director is considering changes to the company’s financial policy. The company, which has always relied entirely on equity financing, is now evaluating the possibility of a share buyback funded through a bond issuance. The company’s shares trade at £4.00 and have 25 million shares outstanding. It plans to buy back 5 million shares at the current market price and issue a 6% bond for the same amount. The company’s profit before interest and tax is expected to remain at £20m indefinitely, with a tax rate of 40%

BW plc’s financial director is considering changes to the company’s financial policy. The company, which has always relied entirely on equity financing, is now evaluating the possibility of a share buyback funded through a bond issuance. The company’s shares trade at £4.00 and have 25 million shares outstanding. It plans to buy back 5 million shares at the current market price and issue a 6% bond for the same amount. The company’s profit before interest and tax is expected to remain at £20m indefinitely, with a tax rate of 40%

1. Consider the impact of the proposed restructuring on expected earnings per share and determine the level of EBIT at which the restructured earnings per share will be the same as a fully equity-funded company.

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

2. Determine the company’s cost of capital prior to any planned restructuring.

  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 any planned restructuring.

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

4. In addition to the above data, assume a personal tax rate of 20 percent on investment income and a personal tax rate of 30 percent on debt investment income. Calculate the adjusted business value after the proposed financial restructuring.

  1. 29
  2. 29
  3. 29
  4. 29

Use the information below to answer questions 5-8.

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

5. Determine the ratio of new shares to old shares based on the terms of the proposed capital increase.

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

6. The investor held 3000 shares of the company prior to the announcement of the stock acquisition rights. She wants to swallow her tail (sell some rights to fund the purchase of new shares without additional investment in the company). How many shares can an investor acquire in a rights issue if he sells the number of rights necessary to achieve a tail swallow?

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

7. Calculate earnings per share and earnings yield if a company completes its public offering.

  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. Rights are traded on the market. A week after the terms of the issue were announced, the stock fell to £2.50. Find the expected theoretical price at the end of the first week, excluding stock acquisition rights.

£2.14

£2.24

£2.34

£2.44

9. Which of the following statements is incorrect?

  1. Heavily discounted rights offerings generate less earnings per share than less discounted rights offerings.
  2. Rights offerings made as part of a best effort underwriting agreement tend to be riskier than those signed as part of the firm commitment process.
  3. Rights offers reduce the wealth of investors that choose not to take up their rights.
  4. Stock price declines in response to public offering announcements are commonly interpreted as evidence of information asymmetry.

10. RG Plc is being acquired by BW Plc, which operates in the same industry and is expected to share similar operational risks with RG Plc. RG Plc has a listed equity beta of 2.5 and a market debt (debt-to-equity) ratio of 1:1. However, BW Plc operates with a debt-to-equity ratio of 1:3 and it is expected that this capital structure will be transferred to RG Plc following the acquisition. What will be the stock beta of RG after being acquired by BW Plc? Corporate tax rate is 30%

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

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