Kaplan Exam Kit, Qno. 45 Arwin

ARWIN Arwin plans to raise $5m in order to expand its existing chain of retail outlets. It can raise the finance by issuing 10% loan stock redeemable in ten years time, or by a rights issue at $4.00 per share. The current financial statements of Arwin are as follows: Statement of profit or loss for the last year Sales revenue Cost of sales 50,000 30,000 Gross profit Administration costs 20,000 14,000 Profit before interest and tax Interest 6,000 300 Profit before tax Taxation at 30% 5,700 1,710 Profit after tax 3,990 Changes in equity Dividends Net change in equity (retained profits) Statement of financial position 2,394 1,596 Net non-current assets Net current assets . 20,100 4,960 25,060 Ordinary shares, par value 25c Retained profit 12% loan stock (redeemable in six years) 2,500 20,060 2,500 25,060 The expansion of business is expected to increase sales revenue by 12% in the first year. variable cost of sales makes up 85% of cost of sales. Administration costs increase by 5% due to new staff appointments. Arwin has a policy of paying out 60 of profit after tax as dividends and has no overdraft. Required: (a) For each financing proposal, prepare the forecast statement of profit or loss after one additional year of operation. (5 marks) (b) Evaluate and comment on the effects of each financing proposal on the following: (i) Financial gearing (ii) Operational gearing (iii) Interest cover (iv) Earnings per share. (12 marks) (c) Comment on the view that businesses are unlikely to have high financial gearing and high operating gearing. (3 marks) (Total: 20 marks) Please help me solve the part B of the question, as I'm confused with financial gearing part and its amounts. Sincere thanks!