Autumn 2005- TBS 907- TUTORIAL 7 SOLUTIONS - LONG TERM FINANCING

Autumn 2005- TBS 907- TUTORIAL 7 SOLUTIONS - LONG TERM FINANCING

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TBS 907- AUTUMN 2005 TUTORIAL 7- LONG TERM FINANCING QUESTION 1 Parbat Ltd. has an issued capital of 2 million ordinary shares of 50 cents each and no fixed interest securities. It has paid a dividend of 70 cents per share for several years, and the stock market generally expects that level to continue. The market price is $4.20 per share cum dividend. The firm is now considering the acceptance of major new investment which would require an outlay of $500,000 and generate net cash receipts of $120,000 per annum for an indefinite period. The additional receipts would be used to increase dividends. Parbat is appraising three alternative sources of finance for the new project. a. Retained Earnings. The usual annual dividend could be reduced. Parbat currently holds $1.4 million for payment of the dividend which is due in the near future. b. A rights issue of ordinary shares. One new share would be offered for every ten shares held at present at a price of $2.50 per share; the new shares would rank for dividend one year after issue, when cash receipts from the new project would be first available. c. An issue of ordinary shares to the general public. The new shares would rank for dividend one year after issue. Assume that, if the project were accepted, the firm’s expectations of future results would be
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