Ali plc is a Stock Exchange listed business. It is all-equity-financed by 40 million 25p ordinary shares, which are currently quoted at £1.60 each. In the recent past, annual profit has been an average of £12.8 million. The average rate of return on capital employed is expected to continue for the future. All of the profit is paid as a dividend each year. The business intends to raise some finance for expansion, through either:

● a one-for-four rights issue at a price of £1.20 per share; or

● an issue of 10 per cent unsecured loan notes to raise the same amount of cash.

Lee is an individual who owns 10,000 of the shares.

Making the same assumptions as were made by Modigliani and Miller in their original proposition on capital gearing (including a world without taxes), calculate and compare the effect on Lee’s income of:

(a) personally borrowing the cash necessary to take up the rights; and

(b) the business deciding to make the loan notes issue instead of the rights issue.

What general conclusion do you draw from this comparison?