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Tin Co (Mar/Jun 18)

Tin Co is planning an expansion of its business operations which will increase profit before interest and tax by 20%. The company is considering whether to use equity or debt finance to raise the $2m needed by the business expansion.

If equity finance is used, a 1 for 5 rights issue will be offered to existing shareholders at a 20% discount to the current ex dividend share price of $5.00 per share. The nominal value of the ordinary shares is $1.00 per share.

If debt finance is used, Tin Co will issue 20,000 8% loan notes with a nominal value of $100 per loan note.

Financial statement information prior to raising new finance:

 

$’000

Profit before interest and tax

1,597

Finance costs (interest)

(315)

Taxation

(282)

Profit after tax

1,000


 

$’000

Equity

 

Ordinary shares

2,500

Retained earnings

5,488

Long-term liabilities:

 

7% loan notes

4,500

Total equity and long-term liabilities

12,488

The current price/earnings ratio of Tin Co is 12.5 times. Corporation tax is payable at a rate of 22%.

Companies undertaking the same business as Tin Co have an average debt/equity ratio (book value of debt divided by book value of equity) of 60.5% and an average interest cover of 9 times.

Required

A. 
(i) Calculate the theoretical ex rights price per share. 
(ii) Assuming equity finance is used, calculate the revised earnings per share after the business expansion.
(iii) Assuming debt finance is used, calculate the revised earnings per share after the business expansion.
(iv) Calculate the revised share prices under both financing methods after the business expansion.
(v) Use calculations to evaluate whether equity finance or debt finance should be used for the planned business expansion.

B. Discuss TWO Islamic finance sources which Tin Co could consider as alternatives to a rights issue or a loan note issue.

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