Equity finance

Question 2 – Long term finance: Equity finance

(a) Lexbel plc generates earnings after tax (PAT) of 20 per cent on shareholders’ funds. Its
current capital structure is as follows:
Ordinary shares of 50p each 300,000
Reserves 400,000
The board of Lexbel plc wishes to raise £180,000 from a right issue in order to expand existing
operations. Its return on shareholders’ funds will be unchanged. The current ex-dividend market
price of Lexbel plc is £1.90. Three different rights issue prices have been suggested by the
finance director: £1.80, £1.60 and £1.40.
(a) Determine the:
i. number of shares to be issued,
ii. theoretical ex-rights price,
iii. expected earnings per share and
iv. form of the issue for each rights issue price, and
v. Present your results in a tabular form and critically evaluate the best option among the three
right issues.
(20 marks)
(b) It has become common for companies to offer their shareholders a choice between a cash
dividend and an equivalent scrip dividend. Critically discuss the advantages of scrip dividends
from the point of view of the company and the shareholders, ensuring the response draws upon
relevant academic research within this highly topical area of financial management.
(30 marks)

Question 3 Investment Appraisal Techniques

Happy Meal Limited a food manufacturer is considering purchasing a new machine for £320,000.
The company is expecting an annual cash inflow of £105,000 from the sale of products and an
annual cash outflow of £15,500 for each of the six years of the machine’s useful life. The annual
cash outflows do not include annual depreciation charges for the machine. The machine is
depreciated using a 20% reducing method. The machine is expected to last for six years, with a
residual value estimated to be at the rate of 10% of the original cost of the machine. The cost of
capital for Happy Meal Limited is 12%.
You are required to:
(a) Calculate using the following investment appraisal techniques, and providebrief
recommendations as to the economic feasibility of acquiring themachine:
i. The Payback Period.
ii. The Accounting Rate of Return.
iii. The Net Present Value.
iv. The Internal Rate of Return (to two decimal places)
(20 marks)
(b) Critically evaluate the benefits and limitations of each of the differing investmentappraisal
techniques, ensuring the response is supported with relevant academic research.

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