Brent Co Ltd. is engaged in the manufacture of shirts involves using sizable quantities of cloth and special thread. A substantial value of inventory is stored at its central warehouse, some miles away from the production site. The company has a fleet of more than 50 vehicles.

Given the volatility in the cloth and special thread market, the risk of changes in the price for these commodities is high. Moreover, the company faces the threat of theft or vandalism to their products at the central warehouse. The company is also exposed to the possibility of fire, theft and accident during the operation of their fleet of vehicles.

Brent Co Ltd is envisaging a growth strategy and intends to apply for a loan of Rs1.0 million with its local bank, with an interest rate swap. It can negotiate a four-year interest rate swap with an 8 per cent fixed rate. Prime rate at the date the contract is set up at 7.5 %. Variable rates for the subsequent years are forecasted at 8.5 %, 9.5 % and 9% respectively.

Required:

(a) Advise Brent Co Ltd on how it can manage the risks facing the company. Assume that the Rs1.0 million loan is contracted. Show relevant workings. (15 marks)

(b) Brent Co Ltd must decide whether to obtain Rs2,000,000 of financing by selling common stock at its current price of Rs40 per share or selling convertible bonds. The firm currently has 250,000 shares of common stock outstanding. Convertible bonds can be sold for their Rs1,000 par value and would be convertible at Rs45. The firm expects its earnings available to common stockholders to be Rs900,000 each year over the next several years.

(i) Calculate the number of shares the firm would need to sell to raise the Rs2,000,000. (1 mark)

(ii) Calculate the earnings per share (EPS) resulting from the sale of common stock. (2 marks)

(iii) Calculate the number of shares outstanding once all bonds have been converted. (3 marks)

(iv) Calculate the earnings per share associated with the bond financing after conversion. (2 marks)

(v) Which of the financing alternatives would you recommend the company to adopt? Why? (2 marks)