Page 69 - Microsoft Word - 00 CIMA F1 Prelims STUDENT 2018.docx

Development of financial strategy

This means that the chances of Seed Co defaulting on its interest
payments will be less if this option goes ahead.

At first glance, it appears that the shareholders will not be happy with this
option, given that EPS reduces from 48.1 cents per share to 43.8 cents
per share, and also given that earnings yield falls from 17.8% to 14.8%.

However, in this situation, where a 1 for 2 rights issue has been used, a
shareholder who owned 2 shares before the rights issue will now own
3 shares (assuming he took up his rights). The rights issue itself makes
no difference to the shareholder's return or wealth. However, the positive
NPV of the project undertaken causes the shareholder return and wealth
to increase.

The increase in earnings attributable to each shareholder's shareholding
will be viewed positively by shareholders, who might expect to see
increased overall dividends in the future.

Once again, overall it is likely that both shareholders and lenders will be
quite happy with the EPS, earnings yield and interest cover ratios if this
financing option is used (assuming that the expected $4m increase in
profit and $8m NPV are achieved).

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