Bar Co is a stock exchange listed company that is concerned by its current level of debt finance.

It plans to make a rights issue and to use the funds raised to pay off some of its debt. The rights

issue will be at a $20\%$ discount to its current ex dividend share price of $$7\mathrm{.}50$ per share and Bar

Co plans to raise $$90m.$ Bar Co believes that paying off some of its debt will not affect its

price$/$earnings ratio, which is expected to remain constant.

STATEMENT OF PROFIT OR LOSS INFORMATION

Revenue

Cost of sales

Profit before interest and tax

Interest

Profit before tax

Tax

Profit after tax

$$m$

Equity

Ordinary shares $($$$1$ nominal$)$

Retained earnings

Long$-$term liabilities

$8\%$ bonds $($ $$100$ nominal$)$

The $8\%$ bonds are currently trading at $$112\mathrm{.}50$ per $$100$ bond and bondholders have agreed that

they will allow Bar Co to buy back the bonds at this market value. Bar Co pays tax at a rate of

$30\%$ per year.

Required

$($a$)$ Calculate the theoretical ex$-$rights price per share of Bar Co following the rights issue.

$($b$)$ Calculate and discuss whether using the cash raised by the rights issue to buy back bonds

is likely to be financially acceptable to the shareholders of Bar Co$,$ commenting in your

answer on the belief that the current price$/$earnings ratio will remain constant.

$($c$)$ Calculate and discuss the effect on the financial risk of Bar Co of using the cash raised by

the rights issue to buy back bonds, as measured by its interest coverage ratio and its book

value debt to equity ratio.

$($d$)$ Discuss the dangers to a company of a high level of gearing, including in your answer an

explanation of the following terms:

$($i$)$ Business risk

$($ii$)$ Financial risk