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Published by: imatache on Dec 01, 2010
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12/04/2012

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VID Inc. is a US-based company, which was established 15 years ago. It makes and distrib-
utes videos, both for the general market and to customer specifications. Its common stock
(shares) have been listed on a US stock exchange for the past 8 years. However, there are
relatively few stockholders and the stock is not traded in large volumes. The founders of the
company no longer participate in its management but own around 10% of the stock in issue.

VID Inc. borrowed US$65 m to purchase new premises three years ago, which have recently
been valued at US$85 m. The company is now considering diversifying into mainstream
film production which will require raising US$50 m for additional fixed and working capi-
tal. This new business will involve joint ventures with UK partners and much of the filming
will be done in the UK or Spain. The new investment is not expected to have a significant
effect on profits for at least 18 months.

The three methods being considered for raising capital are:

(i) New equity in the UK, subject to US stockholders’ approval;
(ii) Long-term fixed rate US$ debt;
(iii) Floating rate sterling-denominated Eurobonds.

Summary financial statistics for the last financial year for VID Inc. are as below.

US$m

Turnover

175.00

Operating profit

45.00

Post-tax profits

31.36

Non-current assets (book value)

95.00

Net current assets

58.00

Long-term loans

8% redeemable 2030

65.00

Common stock (in units of US$1)

25.00

Retained earnings

63.00

Sources of Long-term Finance 55

Share price (US$)

High for year

28.56

Low for year

18.50

As at today (25 May 2004)

22.58

Current annual fixed interest rates for secured long-term borrowing are as follows:

US$6%

UK£7%

European common currency area Euro 5%

Floating rate sterling Eurobond notes are available at the bank base rate 0.5%. Tax will
continue to be payable at 20% per annum.

Requirement

Assume you are a financial adviser to VID Inc. Evaluate the three methods of finance being
considered at the present time and advise the directors of VID Inc. Support your advice
with any calculations you consider appropriate. Assume, for the purposes of this evalua-
tion, that the P/E ratio of the company will rise to 20 if equity finance is used, or 19 if fixed
or floating rate debt is issued. Make only other simplifying assumptions you think neces-
sary and appropriate.

(Total 25 marks)

Note: Up to 10 marks are available for calculations. A report structure is not required for
this question.

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