QUESTION 2 (a) ABC Ltd. has decided to raise capital via a rights issue. The share price is currently K5.50 and ABC intends to raise K5m. There are currently 6.25m shares in issue and ABC is offering a 1 for 5 rights issue. Calculate the Ex-Rights Price. (4 marks) (b) BBC Co is a medium-sized manufacturing company which is considering a 1 for 5 rights issue at a 15% discount to the current market price of K4.00 per share. Issue costs are expected to be K220,000 and these costs will be paid out of the funds raised. It is proposed that the rights issue funds raised will be used to redeem some of the existing loan stock at par. Financial information relating to BBC Co is as follows: Current statement of financial position K'000 K'000 Non-current assets 6,550 Current assets Inventory 2,000 Receivables 1,500 Cash 300 3,800 Total assets 10,350 Ordinary shares (par value 50n) 2,000 Reserves 1,500 12% loan notes 2X12 4,500 Current liabilities Trade payables 1,100 Overdraft 1,250 2,350 Total equity and liabilities 10,350 Other information: Price/earnings ratio of BBC Co: 15.24 Overdraft interest rate: 7% Tax rate: 30% Sector averages: debt/equity ratio (book value): 100% Interest cover: 6 times Required (i) Ignoring issue costs and any use that may be made of the funds raised by the rights issue, calculate: 1. the theoretical ex rights price per share; 2. the value of rights per existing share. (3 marks each) (ii) What alternative actions are open to the owner of 1,000 shares in BBC Co as regards the rights issue? Determine the effect of each of these actions on the wealth of the investor. (8 marks) (c) The BMX Company is planning to invest K10 million in an expansion program which is expected to increase earnings before interest and taxes by K2.5 million. The company currently is earning K5 per share on 1 million shares of common stock outstanding. The capital structure prior to the investment is: Debt K10,000,000 Equity K30,000,000 Total K40,000,000 The expansion can be financed by sale of 200,000 shares at K50 net each, or by issuing long-term debt at a 6 percent interest cost. The firms recent profit and loss statement was as follows: Sales K101,000,000 Variable cost K 60,000,000 Fixed cost 30,500,000 K 90,500,000 Earnings before interest and taxes K 10,500,000 Interest 500,000 Earnings before taxes K 10,000,000 Taxes (50%) 5,000,000 Earnings after taxes K 5,000,000 Assuming the firm maintains its current earnings and achieves the anticipated earnings from the expansion, what will be the earnings per share (1) if the expansion is financed by debt? (5 marks) (2) if the expansion is financed by equity? (5 marks) (Total: 36 marks)