Financial management revision question and answer

CPA-Financial-Management-Section-3 Revision kit

Hisa Limited has 1 million ordinary shares outstanding at the current market price of Sh.50 per share. The company requires Sh.8 million to finance a proposed expansion project. The board of directors has decided to make a one for five rights issue at a subscription price of Sh.40 per share.

The expansion project is expected to increase the firm‟s annual cash inflow by
Sh.945,000. Information on this project will be released to the market together with the announcement of the rights issue.

The company paid a dividend of Sh.4.5 in the previous financial year. This dividend, together with the company‟s earnings is expected to grow 5% annually after investing in the expansion project.

Required:
(i) Compute the price of the shares after the commencement of the rights issue but before they start selling ex-rights.
(ii) Compute the theoretical ex-rights price of the shares.
(iii) Calculate the theoretical value of the rights when the shares are selling rights on.
(iv) What would be the cum-rights price per share if the new funds are used to redeem a Sh.8 million 10% debenture at par? (Assume a corporation tax rate of 30%).
ANSWER

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