Colby Co is planning to raise $11,200,000 through a rights issue. The new shares will be offered at a 20% discount to the current share price of Colby Co, which is $3.50 per share. The rights issue will be on a 1 for 5 basis and issue costs of $280,000 will be paid out of the cash raised. The capital structure of Colby Co is as follows:

                                                                 $m

 Equity

  Ordinary shares (par value $0.50)    10 

 Reserves                                                 75

 Non-current liabilities 8% loan notes 30

 Total                                                        115

 The net cash raised by the issue of rights is used to redeem part of the issue of the loan note. Every borrowing note has a nominal value of $100 and a market value ex interest of $104. A clause in the bond issue contract allows Colby Co at any time before its redemption date to pay the loan notes at a premium of 5 percent at the market price. Colby Co's price/earnings ratio should not be affected by the reimbursement of the loan notes. Colby Co's income per share is currently $0.42 per share and its total income is $8,400,000 per year. The company pays 30 percent corporate tax per year.

 (a)Evaluate the effect on the wealth of the shareholders of Colby Co of using the net rights issue funds to redeem the loan notes.

(b) Discuss whether Colby Co might achieve its optimal capital structure following the rights issue. 

(c) Discuss THREE sources and characteristics of long-term debt finance which may be available to Colby Co.

Answer rating: 100% (QA)

a The effect on the wealth of the shareholders of Colby Co of using the net rights issue funds to redeem the loan notes will be positive By redeeming ... View the full answer