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Hello sir,
Proposal 1
To increase the company’s level of debt by borrowing a further $20 million and use the funds raised to buy back share capital.Ennea: pls explain the reason why have we deducted $17.5million amount from the retained earnings rather than just the interest from the new loan ?
The share are bought back at their market value of $3.20. Therefore they are buying back $20M/3.20 = 6.25M shares.
The nominal value is $0.40 per share, and so using normal financial accounting rules, the share capital is reduced by 6.25M x $0.40 = $2.5M, and the balance of 20 – 2.5 = $17.5M is subtracted from retained earnings.
(The examiner does explain this (and the BPP answer is just a reprint of the examiners answer) under ‘explanations’ below the numerical statements.)
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