The following information is provided for Bessemer Ltd which operates in an industry subject to marked variations in consumer demand.

A corporation tax rate of 30% on reported profit before tax may be assumed; the directors plan to pay out the entire post-tax profit as dividends.

Required:

(a) The forecast dividends for each of the next three years and year-end balance sheet extracts, so far as the information permits, assuming that the expansion is financed by:
(i) issuing additional shares; or 

(ii) issuing loan notes.

(b) Calculate the forecast return on shareholders’ equity, for each of the next three years, under the alternative methods for financing the planned expansion.

(c) An assessment of the merits and demerits of the alternative methods of finance based on the calculations made under (a) and (b) and any other relevant methods of comparison.

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(i) Shareholders' equity at 30 September 2005: Issued ordinary shares of 1 each fully paid Retained profits There were no loans outstanding at the balance sheet date. (ii) Income statement extracts: year to 30 September 2005: Net profit before tax Less Corporation tax (iii) Changes in retained profits: year ending 30 September 2005: Retained profit at 1 October 2004 Dividends paid during year ending 30 September 2005 Profit after tax for year ending 30 September 2005 Retained profit at 30 September 2005 000 5,000 1,650 6,650 000 900 270 630 1,620 (600) 1,020 630 1,650 (iv) The directors are planning to expand output. This will require an additional investment of 2,000,000 which may be financed either by issuing 1,000,000 ordinary shares each with a nominal value of 1, or by raising a 12% loan note. (v) Forecast profits before interest charges, if any, for the year to 30 September: