Question

Please answer all question with working and calculation. Tq

Questions Leeward Co is proposing to raise additional equity finance by means of a rights issue. There are currently om shares in issue with a par value of 50 cents (50.50) trading at $1.50 ex.div per share. The company will offer a share for every 5 shares already held at a 20% discount on the current market price. Issue costs can be ignored. Required: (a) Calculate the theoretical ex-rights price (TERP) and the value of each right. (5 marks) (b) Describe the alternative actions an existing shareholder has in connection with the rights issue and for each, determine the effect on the wealth of the investor. Advise accordingly. (12 marks) (c) The CEO of Leeward Co has suggested that it may prove more cost effective to raise the additional finance by restricting dividend payments. He believes shareholders will understand that if funds are reinvested by the company, this will lead to an overall increase in shareholder wealth. For the last 5 years, the company has maintained a steady rate of dividends out of improving levels of profits and positive cash flow. Required: With reference to underpinning theory, critically evaluate the statement made by the CEO. (8 marks) (Total = 25 marks)

Answer 1

Ans. a). Calculation of theatrical ex - right price =

Market value of shares prior to right issues + cash raised from right issues / Number of shares after right issues

= $ 1.50 X 20 m + $1.20 X 4 m / 20m +4m

= $ 3,48,00,000 / 24,00,000 = $ 1.45

Value of each right = $ 1.50 - $ 1.45 = $ .05

b). Alternative actions an existing shareholder in connection with the right issue and it's effect on the wealth of shareholders :

1). Exercise the rights : Rights can be exercised to subscribe new shares. The exercise price per new share need to be paid.

2). Take no actions and let the rights lapse worthless. Under this option value of their holdings decreses. Rights can lapse worthless or they can result in (small) cash. Take no actions means to leave the rights in their account and do nothing with them.

3). A shareholder can decide to sell his rights. He might want to do this because he might not have funds available to pay for any new shares from the event.

4). Buy additional rights from other shareholders. Shareholders can go in the market and try to buy rights from shareholders who want to sell them.

5). Oversubscribe : in some right issue it is possible to subscribe to more newly issued shares. In case there are more shares being oversubscribed to then there are available, a pro rata allotment will follow. This is also known as scale back.

c). Evaluation of the statement made by the CEO of Leeward company :

To raise the additional finance by restricting dividends will lead in overall increment of shareholders wealth.

Quickly expanding companies typically will not make dividend payments because during pivotal growth stages. It's fiscally shrewder to reinvest the cash back into operations. But, even well established company often reinvesting their earnings, in order to fund new initiatives, aquire other company or pay down debt.

The choice not to pay dividends may be more beneficial to investors from a tax perspective :

Non qualified dividends are taxable to investors as ordinary income, which means an investor'd tax rate on dividend is same as marginal tax rate.

For qualified dividends tax rate is either 0%, 15%, 20% depending on the marginal income tax bracket that the investor falls under.

The capital gain on the sale of appreciated stock can have a lower, long term capital gain tax rate - typically up-to 20% as of 2019, if the investor has held stock for more than one year.

If a company is still growing rapidly won't pay dividends because it wants to invest as much as possible into further growth.