LG Ltd needs to raise $500,000 to finance the acquisition of a new tour bus. It approached an investment bank that proposed the following alternatives:

The issue of 8%, cumulative preference shares for $500,000 with a fixed redemption date 5 year from the date of issue; or

The issue of 10%, non-cumulative, preference shares of $500,000, redeemable at the option of the issuer

The preference share issue is planned for 2019. The accountant prepared an abridged projected statement of financial position for LG Ltd as at 30 June 2019, based on the companys master budget. The projected statement of financial position excludes the effects of the proposed preference share issue or the investment .

Projected Statement of Financial Position as at 30 June 2019
Assets	Amount ($)	Liabilities and Equity	Amount ($)
Assets	2,500,000	Liabilities	1,500,000
		Equity	1,000,000
	2,500,000		2,500,000

Additional information (excluding the effects of the proposed preference share issue or investment ):

LG Ltd estimates profit before interest and tax (EBIT) for the year ended 30 June 2019 as $420,000. This estimate is based on this years performance, adjusted for the effects of the additional investment.

Interest expense in relation to a bank loan included in Liabilities amounts to $100,000.

The bank loan includes a debt covenant which specifies a maximum leverage ratio (total liabilities to total assets) of 60%.

The company has investigated alternative sources of funding and found that most lenders require it to have maintained an interest coverage ratio (EBIT to Interest expense) graeter than 3.0.

Management receives a bonus of 2% of profit before tax, provided the return on investment (EBIT to Total assets) exceeds 12%.

1. Calculate the LG Ltds leverage ratio at 30 June 2019 based on the projected statement of financial position.

2. Prepare a journal entry to record the annual dividend payable on the 8% cumulative and the 10% non-cumulative preference shares.

3. Using the projected figures and estimates provided, calculate LG Ltds leverage ratio and interest coverage ratio assuming the company issues 8% cumulative and the 10% non-cumulative preference shares.

4. Compare LG Ltds profit before tax for each financing alternative.

5. Drawing on the agency theory, explain which financing arrangement would be preferred by management. Where relevant, refer to your analysis of financial statement implications