Question 1 (45 marks) Grandstand Ltd is a medium sized listed company. The company has experienced a growth in earnings and dividends per share over the past five years of between 12% and 20% per annum. The growth has been slowing down over this period and was 12% in the previous year. The shares are presently listed at a dividend yield of 2,5%, which is covered by earnings four times. The company repaid its borrowings three years ago and is currently structured as follows: R'000 Ordinary shares of R3.50 each 21 000 Retained income 174 138 Shareholders' interest 195 138 Represented by: Net operating assets 155 138 Cash on fixed deposit (8% p.a.) 40 000 195 138 After tax return on equity at year end 15.00% The company has decided to acquire a business venture, the operations of which are similar to those of the company. The net operating assets of the venture total R90 million and the agreed cash acquisition price is R100 million. The venture earns a pre-tax income of R17.5 million per annum and has similar growth and risk prospects to that of the company as well as a similar earnings yield. Management is considering two options for financing the acquisition: 1. By means of a rights issue of one share for every share held at a price of R15 per share. 2. By issuing R72 million 10.5% p.a. non-redeemable debentures. The company has indicated that only R28 million of the fixed deposit is available for the financing alternatives proposed. The market is not aware of the negotiations presently being conducted. Assume that the current rates of normal taxation are 28% and ignore issue costs. You may assume that the required rate of return for similar companies that make use of debt in their capital structure is on average 1% higher than those with no gearing. REQUIRED MARKS a Calculate the following, before the acquisition of the business venture i Earnings per share 3 ii Market price per share 2 b Indicate how the acquisition will be financed for each proposed funding arrangement 5 c Assume that the current dividend cover is maintained. Calculate the post - acquisition earnings if: i it is to be financed by means of the rights issue; 4 ii it is to be financed by means of the debenture issue; 4 d Compare the current market price of the shares of Grandstand Limited with the expected market price after the announcement of the acquisition, assuming that the dividend cover is maintained assuming that the dividend cover is maintained and: i it is to be financed by means of the rights issue; 7 ii it is to be financed by means of the debenture issue; 6 e discuss, based on the available information and your calculations above, whether the acquisition should be made and how it should be financed if the acquisition is made; 8 f discuss briefly and in point form why the dividend policy is regarded as irrelevant in certain theories (Miller and Modigliani), whereas it is considered to be relatively important in practice.