Page 314 - AFM Integrated Workbook STUDENT S18-J19
P. 314
Chapter 14
Proposal 2
Easy figures: Increase NCL by $36m. Leave NCA the same and (no
information to the contrary) assume CL stay the same.
Adjust share capital - $36m will buy 12m shares at current market value
of $3. Therefore, reduce share capital by $12m (par value). The balancing
figure of $24m should be debited to reserves.
Adjust forecast after-tax profit to include increased interest charges (both
on the new bonds and the increased coupon on the existing bonds).
Adjust reserves figure to reflect likely decrease in earnings of $1.232m,
then balance off SOFP, entering CA as a balancing figure.
(b) Impact on shareholders
Both proposals give benefits to shareholders.
Proposal 1 could give shareholders an opportunity to liquidate some of
their investment at a fixed share price.
By contrast, proposal 2 would increase the company’s after-tax profits,
giving the possibility of higher dividends in the future.
The shareholders may be concerned about the increased risk which
higher gearing will bring, and because of this, they may need higher
returns to compensate for the higher risk.
However, the gearing of the company would remain low under both
proposals, and interest cover would still be high, so it appears that any
concern from the shareholders is probably unfounded.
Impact on bondholders
Although the current bondholders might be concerned about the extra
gearing which the new bonds would introduce, the higher coupon
payments would be welcomed, especially because (as mentioned above)
the gearing level is not expected to rise too dramatically, and interest
cover will remain high under both proposals.
The current and new bondholders might be more concerned about the
company’s ability to redeem the bonds, but no information is provided as
to how far in the future that is expected to be. A long period to maturity
would allay these sorts of concerns.
The bondholders would expect the directors to explain when and how the
company intends to repay the debt.
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