2 THP Co is planning to buy CRX Co, a company in the same business sector, and is considering paying cash for the
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
current share price.
The purchase price of the 1 million issued shares of CRX Co would be equal to the rights issue funds raised, less
issue costs of $320,000. Earnings per share of CRX Co at the time of acquisition would be 44·8c per share. As a
result of acquiring CRX Co, THP Co expects to gain annual after-tax savings of $96,000.
THP Co maintains a payout ratio of 50% and earnings per share are currently 64c per share. Dividend growth of 5%
per year is expected for the foreseeable future and the company has a cost of equity of 12% per year.
Information from THP Co’s statement of financial position:
Equity and liabilities $000
Shares ($1 par value) 3,000
Reserves 4,300
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7,300
Non-current liabilities
8% loan notes 5,000
Current liabilities 2,200
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Total equity and liabilities 14,500
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Required:
(a) Calculate the current ex dividend share price of THP Co and the current market capitalisation of THP Co
using the dividend growth model. (4 marks)
(b) Assuming the rights issue takes place and ignoring the proposed use of the funds raised, calculate:
(i) the rights issue price per share;
(ii) the cash raised;
(iii) the theoretical ex rights price per share; and
(iv) the market capitalisation of THP Co. (5 marks)
(c) Using the price/earnings ratio method, calculate the share price and market capitalisation of CRX Co before
the acquisition. (3 marks)
(d) Assuming a semi-strong form efficient capital market, calculate and comment on the post acquisition market
capitalisation of THP Co in the following circumstances:
(i) THP Co does not announce the expected annual after-tax savings; and
(ii) the expected after-tax savings are made public. (5 marks)
(e) Discuss the factors that THP Co should consider, in its circumstances, in choosing between equity finance
and debt finance as a source of finance from which to make a cash offer for CRX Co. (8 marks)
(25 marks) 2 (a) Calculation of share price
THP Co dividend per share = 64 x 0·5 = 32c per share
Share price of THP Co = (32 x 1·05)/(0·12 – 0·05) = $4·80
Market capitalisation of THP Co = 4·80 x 3m = $14·4m
(b) Rights issue price
This is at a 20% discount to the current share price = 4·80 x 0·8 = $3·84 per share
New shares issued = 3m/3 = 1m
Cash raised = 1m x 3·84 = $3,840,000
Theoretical ex rights price = [(3 x 4·80) + 3·84]/4 = $4·56 per share
Market capitalisation after rights issue = 14·4m + 3·84m = $18·24 – 0·32m = $17·92m
This is equivalent to a share price of 17·92/4 = $4·48 per share
The issue costs result in a decrease in the market value of the company and therefore a decrease in the wealth of shareholders
equivalent to 8c per share.
(c) Price/earnings ratio valuation
Price/earnings ratio of THP Co = 480/64 = 7·5
Earnings per share of CRX Co = 44·8c per share
Using the price earnings ratio method, share price of CRX Co = (44·8 x 7·5)/100 = $3·36
Market capitalisation of CRX Co = 3·36 x 1m = $3,360,000
(Alternatively, earnings of CRX Co = 1m x 0·448 = $448,000 x 7·5 = $3,360,000)
(d) In a semi-strong form efficient capital market, share prices reflect past and public information. If the expected annual
after-tax savings are not announced, this information will not therefore be reflected in the share price of THP Co. In this case,
the post acquisition market capitalisation of THP Co will be the market capitalisation after the rights issue, plus the market
capitalisation of the acquired company (CRX Co), less the price paid for the shares of CRX Co, since this cash has left the
company in exchange for purchased shares. It is assumed that the market capitalisations calculated in earlier parts of this
question are fair values, including the value of CRX Co calculated by the price/earnings ratio method.
Price paid for CRX Co = 3·84m – 0·32m = $3·52m
Market capitalisation = 17·92m + 3·36m – 3·52m = $17·76m
This is equivalent to a share price of 17·76/4 = $4·44 per share
The market capitalisation has decreased from the value following the rights issue because THP Co has paid $3·52m for a
company apparently worth $3·36m. This is a further decrease in the wealth of shareholders, following on from the issue costs
of the rights issue.
If the annual after-tax savings are announced, this information will be reflected quickly and accurately in the share price of
THP Co since the capital market is semi-strong form efficient. The savings can be valued using the price/earnings ratio method
as having a present value of $720,000 (7·5 x 96,000). The revised market capitalisation of THP Co is therefore $18·48m
(17·76m + 0·72m), equivalent to a share price of $4·62 per share (18·48/4). This makes the acquisition of CRX Co
attractive to the shareholders of THP Co, since it offers a higher market capitalisation than the one following the rights issue.
Each shareholder of THP Co would experience a capital gain of 14c per share (4·62 – 4·48).
In practice, the capital market is likely to anticipate the annual after-tax savings before they are announced by THP Co.
(e) There are a number of factors that should be considered by THP Co, including the following.
Gearing and financial risk
Equity finance will decrease gearing and financial risk, while debt finance will increase them. Gearing for THP Co is currently
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 some acquired debt finance in the capital structure of CRX Co. THP Co needs to consider what level of financial risk is
desirable, from both a corporate and a stakeholder perspective.
Target capital structure
THP Co needs to compare its capital structure after the acquisition with its target capital structure. If its primary financial
objective is to maximise the wealth of shareholders, it should seek to minimise its weighted average cost of capital (WACC).
In practical terms this can be achieved by having some debt in its capital structure, since debt is relatively cheaper than equity,
while avoiding the extremes of too little gearing (WACC can be decreased further) or too much gearing (the company suffers
from the costs of financial distress).
Availability of security
Debt will usually need to be secured on assets by either a fixed charge (on specific assets) or a floating charge (on a specified
class of assets). The amount of finance needed to buy CRX CO would need to be secured by a fixed charge to specific fixed
assets of THP Co. Information on these fixed assets and on the secured status of the existing 8% loan notes has not been
provided.
Economic expectations
If THP Co expects buoyant economic conditions and increasing profitability in the future, it will be more prepared to take on
fixed interest debt commitments than if it believes difficult trading conditions lie ahead.
Control issues
A rights issue will not dilute existing patterns of ownership and control, unlike an issue of shares to new investors. The choice
between offering new shares to existing shareholders and to new shareholders will depend in part on the amount of finance
that is needed, with rights issues being used for medium-sized issues and issues to new shareholders being used for large
issues. Issuing traded debt also has control implications however, since restrictive or negative covenants are usually written
into the bond issue documents.
Workings
Current gearing (debt/equity, book value basis) = 100 x 5,000/7,300 = 68·5%
Gearing if equity finance is used = 100 x 5,000/(7,300 + 3,840) = 45%
Gearing if debt finance is used = 100 x (5,000 + 3,840)/7,300 = 121% | 
发表于 2008-10-11 16:04
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