Cavendish plc is a Stock Exchange listed business whose main activity is producing a low-value material used
Question:
Cavendish plc is a Stock Exchange listed business whose main activity is producing a low-value material used in large quantities in the building/construction industries.
Production is such that a large proportion of its costs are fixed relative to the level of output.
The business is financed by a combination of ordinary shares and loan stocks. At present the capital gearing ratio is a little below the average for businesses in the building materials industry.
Cavendish plc has identified a possible investment opportunity in taking over the operation of a smaller business, Darley Ltd, which is involved in producing another,
more recently developed building material, which is increasingly being used as a substitute for a more traditional material. The decision has been taken to make the acquisition, and a price has been negotiated with the owners of Darley Ltd. The owners will only accept cash as the consideration for the acquisition. The acquisition will expand Cavendish plc’s total funds invested by around 20 per cent.
Cavendish plc does not have sufficient cash to be able to finance the acquisition without making some form of capital issue. For various reasons, including potential loss of the economies of scale in respect of issue costs, the directors have decided either to make a rights issue of equities or a loan stock issue, rather than a combination of the two.
A board meeting has been scheduled to make a decision as to the means of financing the acquisition.
In advance of the meeting, individual directors of Cavendish plc have made the following comments:
l Director A: ‘We don’t want to make a rights issue of equities at present. With this depression in the construction industry dragging our share price down, we are going to have to issue a lot of shares to get the amount needed.’
l Director B: ‘The trouble with a loan stock issue is that it will push our gearing level above the sector average and that won’t help our share price.’
l Director C: ‘My daughter is taking a business finance course as part of her degree, and she has told me that there’s a theory that it doesn’t make any difference to the existing shareholders whether new finance is raised from a share issue or by borrowing.’
Prepare some notes that will brief the directors, in advance of the meeting, on the likely key issues that they will need to consider, including the points that have already been made to you.
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