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hello Sir ,
I don t understand why do we compare the revsied share price of 7.08 to theoretical ex right price of 7.20
moreover please explain the last three lines of part b which are as follow:“If the share price increases to above the theoretical ex rights price per share, corresponding to an increase
in the price/earnings ratio to more than 17 times (720/42·37), shareholders will experience a capital gain and so using the
cash raised by the rights issue to buy back bonds will become financially acceptable from their perspective.”
kind RegardsThe theoretical ex-rights price is the price that the shares would have to be for shareholders to make no gain/no loss.
Since the revised share price is lower than the theoretical ex-rights price it means that shareholders will be worse off (and therefore it will not be acceptable to them).
The last three lines are making the point that in fact the actual price might be higher than the theoretical price, in which case it will be financially acceptable.
Sir for Part (c) when calculating gearing, i understand that we have to have a double entry for bond redemption for $90m. But can you please explain y are we reducing 10m from “equity”. Does that mean we reduce share premium amount to pay the premium above nominal value? Havent ever done a question with premium being reduced from equity.
This is basic accounts.
The equity (share capital plus reserves) is always equal to the net assets of the business.
If bonds are repaid at par, then net assets (and therefore equity) will not change.
If bonds are repaid at a premium, then net assets fall and therefore equity falls, but the amount of the premium.Hi sir
in part c, we are asked to calculate Book value debt to equity ratio afyer bonds are redeemed. for the ord shares in equity part, its 60 million plus 90 million. I feel it should be 60 million plus 15million rights at their nominal value of $1. and i feel we must deduct the profit after tax before the redemption from the retained earnings and add the revised profit after redemption to retained earnings.
Why am i wrong in thinking so?
Kindly clarify
ThanksAlthough the shares issued have a nominal value of $15M, they are raising $90M and any extra goes to a share premium account which is part of the total equity.
As far as the profit after tax is concerned, this profit has already been made (and is already included in reserves) and will not be changed by the rights issue and repayment of the bonds.
Thanks for the clarification on shares.
But for profit after tax, it changes because of the interest saving from the redeemed bonds. so why do we not increase the reserves by that amount?
I know it seems a bit inconsistent (taking the interest into account in the interest coverage ratio, but ignoring it in calculating the gearing ratio), and I don’t think therefore that you would be penalised if you had done what you are suggesting. The examiner was looking at the two things independently, and the immediate effect on the gearing would not be changed by the interest – only the affect in future (and in future the gearing will change anyway because of future profits).
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