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question :1
Tefex Ltd is considering the raising of new long-term finance. It has decided to issue either preference shares or debentures as the ordinary shareholders have only recently been asked to subscribe to a rights issue.
What do you think are the main issues that should be considered when deciding between preference shares and debentures?question :2
Volex began trading as a retailer and in the first year made a loss of £210,000. In the second year of trading it made a trading profit of £250,000 and in the third year of trading it made a trading profit of £140,000. In the third year the company also sold a shop for £400,000 that had originally cost £320,000. It also issued £100,000 ordinary shares at a premium of £1 per share.
What is the maximum dividend the company can issue in each year of trading?Are there homework questions? (Because otherwise you presumably have the answers in whichever book you found the questions!).
The first question isn’t really an F3 question (it is more F9).
As far as F3 is concerned all you are expected to know is that debenture interest is paid before dividends (and therefore preference shares are more risk than debentures for the investor). That preference dividends are fixed and are paid before ordinary dividends (so preference shares are less risk than ordinary shares for the investor). And that debenture interest is tax allowable for the company whereas dividends are not tax allowable – which make the net cost of debentures lower for the company.For your second question, you have asked it before and I have answered you before.
The maximum dividend that can be paid is the total retained earnings. So they can’t pay anything in the first year. The maximum in the second year is 40,000. The maximum in the third year is impossible to calculate for two reasons – partly because it suggests that the profit on sale of shop has not been included in the 140,000. The profit on sale can be paid as dividend (because it has been sold, not simply revalued) but we cannot calculate the profit because we don’t know how much depreciation there has been. Secondly, although the 140,000 is certainly payable as dividend (plus the profit from the shop) they can also pay out any of the 40,000 from the second year that wasn’t paid out as dividend in the second year.
(PS we don’t issue dividends – we pay dividends 🙂 )
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