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    Revised Balance Sheet, Financial Ratios

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    The summarised Balance Sheet of Omicron Ltd at 31 December 2002 was as follows:

    Fixed assets 1900
    Net current assets 1500
    3400
    10% debentures 2003/2004 400
    3000
    Share capital and reserves
    Ordinary shares of $1 1000
    8% preference shares of $1 800
    Share Premium account 180
    Profit and Loss Account 1020
    3000

    On 1 January 2003 before any other transactions had taken place the following occurred.
    1. Redemption of all the debentures at a premium of 5%.
    2. Redemption of all the preference shares at $1.25 per share. The shares had originally been issued at $1.10 per share.

    REQUIRED
    (a) A revised Balance Sheet at 1 January 2003 as it appeared after the redemption of the debentures and the preference shares.

    Omicron Ltds profit before interest for the year ended 31 December 2002 was $600000. A dividend of $0.40 was paid on its ordinary shares for the year. The ordinary shares were quoted at $3.50 on 31 December 2002 and at $3.84 on 1 January 2003 after the redemption of the debentures and preference shares.
    REQUIRED
    (b) Calculate the following ratios both at 31 December 2002 and on 1 January 2003 after the debentures and preference shares had been redeemed. Give your answers to two decimal places.
    (I) Gearing
    (i Dividend cover
    (iii) Earnings per share (EPS)
    (iv) Price earnings ratio (PER)
    (v) Dividend yield [

    REQUIRED
    (c) Comment on the changes in the ratios you have calculated in (b) as a result of the transactions in (a).

    In May 2003 the directors of Omicron Ltd plan to build an additional factory. This requires initial capital expenditure of $600000 and is expected to start producing revenue and be profitable in three years' time. The directors are considering raising the additional funds for the project by one of the following methods.
    1. The issue of 12% debentures 2006 at par.
    2. A rights issue of ordinary shares at $4 per share.
    3. An issue of ordinary shares to the public at $4 per share.
    The present rate of ordinary dividend would be maintained on all the old and new shares for the foreseeable future.
    REQUIRED
    (d) Discuss each of the methods of raising the capital, and state with reasons which method the directors should choose.

    © BrainMass Inc. brainmass.com December 24, 2021, 4:48 pm ad1c9bdddf
    https://brainmass.com/business/working-capital-management/revised-balance-sheet-financial-ratios-8062

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    SOLUTION This solution is FREE courtesy of BrainMass!

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    Solution

    (a) A revised Balance Sheet at 1 January 2003 as it appeared after the redemption of the debentures and the preference shares.

    Recasting the summarised balance sheet with Assets on one side and Shareholder's equity and liabilities on the other
    The summarised Balance Sheet of Omicron Ltd as on 31 December 2002
    Assets Liabilities + Shareholder's Equity
    in '000 $ in '000 $
    10% debentures 2003/2004 400
    Fixed assets 1900 Share capital and reserves
    Net current assets 1500 Ordinary shares of $1 1000
    3400 8% preference shares of $1 800
    Share Premium account 180
    Profit and Loss Account 1020
    3400

    On 1 January 2003 before any other transactions had taken place the following occurred.
    1. Redemption of all the debentures at a premium of 5%.
    2. Redemption of all the preference shares at $1.25 per share. The shares had originally been issued at $1.10 per share.

    1 Redemption of all debentures
    Amount required=1.05*400= 420
    Thus total cash outflow= 420
    Net current assets will be reduced by 420
    Net current assets =1500-420= 1080
    On the liabilities side
    10% debentures 2003/2004=400-400= 0
    Share Premium account will be reduced by 20
    Share Premium account=180-20= 160

    2. Redemption of all the preference shares at $1.25 per share. The shares had originally been issued at $1.10 per share.

    Amount required=800*1.25= 1000
    Thus total cash outflow= 1000
    Net current assets will be reduced by 1000
    Net current assets =1080-1000= 80

    On the liabilities side
    8% preference shares of $1=800-800 0
    The share premium account is insufficient to meet the requirement of additional 200 as it has already been reduced to 160
    Share Premium account will be reduced by 160
    Share Premium account=160-160= 0
    Additional 40 will be reduced from Profit and loss account
    Profit and Loss Account =1020-40 980

    The summarised Balance Sheet of Omicron Ltd as on 1 January 2003
    Assets Liabilities + Shareholder's Equity
    in '000 $ in '000 $
    10% debentures 2003/2004 0
    Fixed assets 1900 Share capital and reserves
    Net current assets 80 Ordinary shares of $1 1000
    1980 8% preference shares of $1 0
    Share Premium account 0
    Profit and Loss Account 980
    1980

    (b) Calculate the following ratios both at 31 December 2002 and on 1 January 2003 after the debentures and preference shares had been redeemed. Give your answers to two decimal places.
    (I) Gearing
    (i Dividend cover
    (iii) Earnings per share (EPS)
    (iv) Price earnings ratio (PER)
    (v) Dividend yield [

    Omicron Ltds profit before interest for the year ended 31 December 2002 was $600000. A dividend of $0.40 was paid on its ordinary shares for the year. The ordinary shares were quoted at $3.50 on 31 December 2002 and at $3.84 on 1 January 2003 after the redemption of the debentures and preference shares.
    in '000 $
    Profits before interest 600

    Less Interest on debentures=10%*400= 40
    Less Dividend on preference shares=8%*800= 64
    Profit for distribution among ordinary shares= 496

    Gearing ratio=Debt(Debentures)/Total capital employed
    Dividend cover=Dividend /Earnings
    EPS=Total earnings/No of ordinary shares
    PER=Price per share/Earning per share
    Dividend yield=Dividend per share/Price of share
    All figures except price per share and dividend per share in '000 $

    31 December 2002 1-Jan-03

    Price per share 3.5 3.84
    Earnings after interest and payment of dividends to preference shares 496 600
    No of ordinary shares 1000 1000
    Total dividend=1000*$0.40= 400 400
    Dividend per share= 0.4 0.4

    Ratios

    Gearing 0.12 =400/3400 0.00 =0/1980
    Dividend cover 1.24 =496/400 1.50 =600/400
    Earnings per share (EPS) 0.50 =496/1000 0.60 =600/1000
    Price earnings ratio (PER) 7.00 =3.5/0.50 6.40 =3.84/0.60
    Dividend yield 0.11 =0.4/3.5 0.10 =0.4/3.84

    (c) Comment on the changes in the ratios you have calculated in (b) as a result of the transactions in (a).

    The gearing ratio has come down as the company has become debt free
    The dividend cover and EPS have improved as no interest payment and dividend for preference share is to be given.

    The price earning ratio has come down as the EPS has increased more than the proportionate increase in share price
    The dividend yield has decreased as the price of the share has appreciated.

    In May 2003 the directors of Omicron Ltd plan to build an additional factory. This requires initial capital expenditure of $600000 and is expected to start producing revenue and be profitable in three years' time. The directors are considering raising the additional funds for the project by one of the following methods.
    1. The issue of 12% debentures 2006 at par.
    2. A rights issue of ordinary shares at $4 per share.
    3. An issue of ordinary shares to the public at $4 per share.
    The present rate of ordinary dividend would be maintained on all the old and new shares for the foreseeable future.
    REQUIRED
    (d) Discuss each of the methods of raising the capital, and state with reasons which method the directors should choose.

    1) Issue of debt:

    There are a number of ways in which companies can borrow money. Debenture is a promissory note that is only backed by the general credit of the company and not secured by a mortgage or lien on any specific property of the company.The company promises to make regular interest payments and to repay the principal amount according to an agreed schedule. The company's liability is limited, so lenders can only look to the earnings of the company for their payment. Lenders cannot look beyond these to the shareholders for repayment.

    2) Rights Issue

    Rights issue can be a very effective and inexpensive way of raising additional funding. The issue is offered to the firm's existing stockholders in proportion to their current holding in the company. Rights issue effectively avoids wealth transfer between existing stockholders and new stockholders, since they are one and the same. Therefore, the actual pricing of the issue is of little consequence.

    3)Issue of ordinary shares

    Public issue of ordinary shares : General cash offers are made to the public.The disadvantages are high cost of issue and underpricing of shares. Under-pricing can transfer wealth from one group of share holders to another.

    The directors should choose the rights issue.The earnings are sufficient to cover the dividend payment.The payout will be less than in the case of debentures
    Rights issue
    No of shares (in '000)=600/4=150
    Dividend payment=150*0.40=60((in '000$)

    Debentures
    Interest payment (in '000$)=0.12*600=$72(in '000$)

    Also as explained above Rights issue is less expensive than issue of ordinary shares and the actual pricing of the issue is of little consequence.

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    © BrainMass Inc. brainmass.com December 24, 2021, 4:48 pm ad1c9bdddf>
    https://brainmass.com/business/working-capital-management/revised-balance-sheet-financial-ratios-8062

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