Rights issues

I assume that you had no problem with part (a) of the question.

Part (b) asks if the proposal is likely to be financially acceptable to the shareholders (i.e whether or not it will increase the value of the shares). It specifically tells you that the PE ratio will remain constant, and so you need to calculate the effect on the EPS (given there will be less interest payable, but more shares in issue) and then multiply by the PE ratio to get the market value. (This is not directly related to rights issues on general).

Again, part (c) is not directly related to rights issues. Obviously buying back bonds will mean less interest payable and therefore affect the interest cover. Similarly, the equity and the debt will both change in the SOFP (more equity because of the rights issue, and less debt because of repaying), and therefore the debt to equity ratio (the gearing ratio) will change. These ratios are all explained in my lectures.

As it typical in Section C of the exam, this question is testing several different topic – rights issues; PE valuations; ratios; and gearing.

As far as lectures working through past questions are concerned, there are lots of them – they are linked from ‘Revision Kit Live’ from the main F9 page.