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:

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.