The Merton Manufacturing Co Ltd has been in business for many years making fitted furniture and chairs. During 2004 and 2005 substantial losses have been sustained on the manufacture of chairs and the directors have decided to concentrate on the fitted furniture side of the business which is expected to produce a profit of at least £22,500 per annum before interest charges and taxation. A capital reduction scheme has been proposed under which:

(i) a new ordinary share of 50p nominal value will be created;

(ii) the 1 ordinary shares will be written off and the shareholders will be offered one new ordinary share for every six old shares held;

(iii) the 16% redeemable preference shares will be cancelled and the holders will be offered for every three existing preference shares one new ordinary share;

(iv) the existing 11% loan note will be exchanged for a new loan note yielding 8% at a rate of two old loan notes for three new loan notes. In addition, existing loan-note holders will be offered one new ordinary share for every 4 of the old loan note held;

(v) existing reserves will be written off;
(vi) goodwill is totally impaired and to be written off:
(vii) any remaining balance of write-off which is necessary is to be achieved by writing down plant and equipment; and (viii) existing ordinary shareholders will be invited to subscribe for two fully paid new ordinary shares at par for every three old shares held.
The balance sheet of the Merton Manufacturing Co Ltd immediately prior to the capital reduction is as follows:

On liquidation, freehold land and buildings are expected to produce £120,000; plant and equipment £40,000; inventory £15,000; and accounts receivable £45,000. Goodwill has no value.
There are no termination costs associated with ceasing the manufacture of chairs.

Required:

(a) Assuming that the necessary approval is obtained and that the new share issue is successful, produce a balance sheet of the company showing the position immediately after the scheme has been put into effect.

(b) Show the effect of the scheme on the expected earnings of the old shareholders.

(c) Indicate the points which a preference shareholder should take into account before voting on the scheme.
Corporation tax may be taken at 33-1/3%.

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Non-current intangible assets E f 3 Goodwill 50,000 Non-current tangible assets Freehold land and buildings at cost 95,000 Plant and equipment at cost 275,000 Less Depreciation to date (89,500) 185,500 330,500 Current assets Inventory Accounts receivable Total assets Current liabilities Accounts payable 25,000 50,000 75,000 405,500 63,500 Bank overdraft 15,850 79,350 Non-current liabilities 11% loan note, secured on the freehold land and buildings Total liabilities Net assets Equity 1 ordinary shares fully paid 6% 1 redeemable preference shares fully paid Share premium account Retained profits 100,000 179,350 226,150 90,000 150,000 25,000 (38,850) 226,150