LONG-TERM SOURCES: EXERCISE 1

QUESTION 1

What are the advantages and disadvantages of using common stock as a source of business
finance from the point of view of:

(a) The company

(b) The shareholders?

QUESTION 2

Why might a company prefer a rights offering rather than a general offer of new shares to the
public?

QUESTION 3

How many shares must a minority group of shareholders own in order to assure election of 2
directors if 9 new directors will be elected at the next AGM and 200,000 shares are
outstanding. Assume cumulative voting exists.

QUESTION 4

A company needs to raise K4,000,000 to pay for equipment. It will raise the funds by offering
400,000 rights, each of which entitles the owners to buy one new share. The company currently
has outstanding 2 million shares priced at K40 each.

(i) What will be the subscription price on the rights the company plans to offer?

(ii) What will be the share price after the rights issue?

(iii) What is the value of a right?

(iv) How many rights would be issued to an investor who currently owns 1,000
shares?

QUESTION 5

Trends Ltd. is proposing a rights offering. Presently, there are 350,000 shares outstanding at
K100 each. There will be 50,000 new shares offered at K90 each.
 (i) What is the new market value of the company?

(ii) How many rights are required to buy one new share?

(iii) What is the ex-rights price?

(iv) What is the value of a right?

QUESTION 6

ABC Company had total assets of K7,000,000 last year. Its income statement at the end of last
year is shown below.

Earnings rate: 10% on total assets

EBIT K700,000

Interest 105,000

EBT K595,000

Taxes (40%) 238,000

EAIT K357,000

EPS K7.14

Dividends per share (50% of earnings) K3.57

Price-earnings ratio 7.5 times

Market price per share K53.55

The company plans to raise an additional K2.5 million through a rights offering. The
additional funds will continue to earn 10%. The P/E ratio is assumed to remain at 7.5
times, the dividend pay-out will continue to be 50% and 40% tax rate will remain in
effect.
 Assuming a subscription price of K50 a share:

• How many additional shares will have to be sold?

• How many rights will be required to buy one new share?

• What will be the new EPS?

• What will be the new market price per share?

• What will be the value of one right?

• Suppose you held 50 shares of ABC Company before the rights offering. After you
exercise your rights, what is the net value of your position?

END OF EXERCISE