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<p>2 THP Co is planning to buy CRX Co, a company in the same business sector, and is considering paying cash for the<br/>shares of the company. The cash would be raised by THP Co through a 1 for 3 rights issue at a 20% discount to its<br/>current share price.<br/>The purchase price of the 1 million issued shares of CRX Co would be equal to the rights issue funds raised, less<br/>issue costs of $320,000. Earnings per share of CRX Co at the time of acquisition would be 44·8c per share. As a<br/>result of acquiring CRX Co, THP Co expects to gain annual after-tax savings of $96,000.<br/>THP Co maintains a payout ratio of 50% and earnings per share are currently 64c per share. Dividend growth of 5%<br/>per year is expected for the foreseeable future and the company has a cost of equity of 12% per year.<br/>Information from THP Co’s statement of financial position:<br/>Equity and liabilities $000<br/>Shares ($1 par value) 3,000<br/>Reserves 4,300<br/>––––––<br/>7,300<br/>Non-current liabilities<br/>8% loan notes 5,000<br/>Current liabilities 2,200<br/>–––––––<br/>Total equity and liabilities 14,500<br/>–––––––<br/>Required:<br/>(a) Calculate the current ex dividend share price of THP Co and the current market capitalisation of THP Co<br/>using the dividend growth model. (4 marks)<br/>(b) Assuming the rights issue takes place and ignoring the proposed use of the funds raised, calculate:<br/>(i) the rights issue price per share;<br/>(ii) the cash raised;<br/>(iii) the theoretical ex rights price per share; and<br/>(iv) the market capitalisation of THP Co. (5 marks)<br/>(c) Using the price/earnings ratio method, calculate the share price and market capitalisation of CRX Co before<br/>the acquisition. (3 marks)<br/>(d) Assuming a semi-strong form efficient capital market, calculate and comment on the post acquisition market<br/>capitalisation of THP Co in the following circumstances:<br/>(i) THP Co does not announce the expected annual after-tax savings; and<br/>(ii) the expected after-tax savings are made public. (5 marks)<br/>(e) Discuss the factors that THP Co should consider, in its circumstances, in choosing between equity finance<br/>and debt finance as a source of finance from which to make a cash offer for CRX Co. (8 marks)<br/>(25 marks)</p><p></p><p>2 (a) Calculation of share price<br/>THP Co dividend per share = 64 x 0·5 = 32c per share<br/>Share price of THP Co = (32 x 1·05)/(0·12 – 0·05) = $4·80<br/>Market capitalisation of THP Co = 4·80 x 3m = $14·4m<br/>(b) Rights issue price<br/>This is at a 20% discount to the current share price = 4·80 x 0·8 = $3·84 per share<br/>New shares issued = 3m/3 = 1m<br/>Cash raised = 1m x 3·84 = $3,840,000<br/>Theoretical ex rights price = [(3 x 4·80) + 3·84]/4 = $4·56 per share<br/>Market capitalisation after rights issue = 14·4m + 3·84m = $18·24 – 0·32m = $17·92m<br/>This is equivalent to a share price of 17·92/4 = $4·48 per share<br/>The issue costs result in a decrease in the market value of the company and therefore a decrease in the wealth of shareholders<br/>equivalent to 8c per share.<br/>(c) Price/earnings ratio valuation<br/>Price/earnings ratio of THP Co = 480/64 = 7·5<br/>Earnings per share of CRX Co = 44·8c per share<br/>Using the price earnings ratio method, share price of CRX Co = (44·8 x 7·5)/100 = $3·36<br/>Market capitalisation of CRX Co = 3·36 x 1m = $3,360,000<br/>(Alternatively, earnings of CRX Co = 1m x 0·448 = $448,000 x 7·5 = $3,360,000)<br/>(d) In a semi-strong form efficient capital market, share prices reflect past and public information. If the expected annual<br/>after-tax savings are not announced, this information will not therefore be reflected in the share price of THP Co. In this case,<br/>the post acquisition market capitalisation of THP Co will be the market capitalisation after the rights issue, plus the market<br/>capitalisation of the acquired company (CRX Co), less the price paid for the shares of CRX Co, since this cash has left the<br/>company in exchange for purchased shares. It is assumed that the market capitalisations calculated in earlier parts of this<br/>question are fair values, including the value of CRX Co calculated by the price/earnings ratio method.<br/>Price paid for CRX Co = 3·84m – 0·32m = $3·52m<br/>Market capitalisation = 17·92m + 3·36m – 3·52m = $17·76m<br/>This is equivalent to a share price of 17·76/4 = $4·44 per share<br/>The market capitalisation has decreased from the value following the rights issue because THP Co has paid $3·52m for a<br/>company apparently worth $3·36m. This is a further decrease in the wealth of shareholders, following on from the issue costs<br/>of the rights issue.<br/>If the annual after-tax savings are announced, this information will be reflected quickly and accurately in the share price of<br/>THP Co since the capital market is semi-strong form efficient. The savings can be valued using the price/earnings ratio method<br/>as having a present value of $720,000 (7·5 x 96,000). The revised market capitalisation of THP Co is therefore $18·48m<br/>(17·76m + 0·72m), equivalent to a share price of $4·62 per share (18·48/4). This makes the acquisition of CRX Co<br/>attractive to the shareholders of THP Co, since it offers a higher market capitalisation than the one following the rights issue.<br/>Each shareholder of THP Co would experience a capital gain of 14c per share (4·62 – 4·48).<br/>In practice, the capital market is likely to anticipate the annual after-tax savings before they are announced by THP Co.<br/>(e) There are a number of factors that should be considered by THP Co, including the following.<br/>Gearing and financial risk<br/>Equity finance will decrease gearing and financial risk, while debt finance will increase them. Gearing for THP Co is currently<br/>68·5% and this will decrease to 45% if equity finance is used, or rise to 121% if debt finance is used. There may also be</p><p>some acquired debt finance in the capital structure of CRX Co. THP Co needs to consider what level of financial risk is<br/>desirable, from both a corporate and a stakeholder perspective.<br/>Target capital structure<br/>THP Co needs to compare its capital structure after the acquisition with its target capital structure. If its primary financial<br/>objective is to maximise the wealth of shareholders, it should seek to minimise its weighted average cost of capital (WACC).<br/>In practical terms this can be achieved by having some debt in its capital structure, since debt is relatively cheaper than equity,<br/>while avoiding the extremes of too little gearing (WACC can be decreased further) or too much gearing (the company suffers<br/>from the costs of financial distress).<br/>Availability of security<br/>Debt will usually need to be secured on assets by either a fixed charge (on specific assets) or a floating charge (on a specified<br/>class of assets). The amount of finance needed to buy CRX CO would need to be secured by a fixed charge to specific fixed<br/>assets of THP Co. Information on these fixed assets and on the secured status of the existing 8% loan notes has not been<br/>provided.<br/>Economic expectations<br/>If THP Co expects buoyant economic conditions and increasing profitability in the future, it will be more prepared to take on<br/>fixed interest debt commitments than if it believes difficult trading conditions lie ahead.<br/>Control issues<br/>A rights issue will not dilute existing patterns of ownership and control, unlike an issue of shares to new investors. The choice<br/>between offering new shares to existing shareholders and to new shareholders will depend in part on the amount of finance<br/>that is needed, with rights issues being used for medium-sized issues and issues to new shareholders being used for large<br/>issues. Issuing traded debt also has control implications however, since restrictive or negative covenants are usually written<br/>into the bond issue documents.<br/>Workings<br/>Current gearing (debt/equity, book value basis) = 100 x 5,000/7,300 = 68·5%<br/>Gearing if equity finance is used = 100 x 5,000/(7,300 + 3,840) = 45%<br/>Gearing if debt finance is used = 100 x (5,000 + 3,840)/7,300 = 121%</p> thx 3q 3Q页:
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