Question
The following is an extract from the balance sheet of Leisure International plc at 30 June 2019: 000 Ordinary shares of 50p each 5,200 Reserves
The following is an extract from the balance sheet of Leisure International plc at 30 June 2019:
000
Ordinary shares of 50p each 5,200
Reserves 4,850
9% preference shares of 1 each 4,500
14% debentures 5,000
Total long-term funds 19,550
The ordinary shares are quoted at 80 p. Assume that the market estimate of the next ordinary dividend is 4 p, growing thereafter at 12% per annum indefinitely. The preference shares, which are irredeemable, are quoted at 72 p and the debentures are quoted at par. Corporation tax is 35%.
D) Assume that instead of raising 5 m of 14% debentures, the company had raised the equivalent amount in preference shares giving the same yield as the existing preference capital.
You are required:
- To demonstrate that the returns offered to investors in the two financial instruments are consistent with investor risk aversion;
- To calculate how Leisure International plcs equity earnings would have been affected if the preference shares had been issued instead of the debentures.
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