NewHorizons Plc is a travel company specialising in cruises. Its profits and cash flows have recently been
Question:
NewHorizons Plc is a travel company specialising in cruises. Its profits and cash flows have recently been severely affected by Covid and it has very limited cash flows in reserves and an overdraft of £150,000. It currently has 900,000 shares in issue. It also has a bond valued at £250,000 which is redeemable in 4 years' time.
The board of directors is considering an investment opportunity that has arisen, at a cost of £300,000. This investment opportunity is in an area that the company is familiar with and knowledgeable about and is forecast to better position the company in the post-pandemic world.
There is disagreement amongst the board as to how the required funding should be raised.
- Director 1 wants to raise it via a rights issue. The current share price is £4.00, but she would like to offer a rights price of £3.00 per share, to encourage the shareholders to take up the rights.
- Director 2 wants to obtain an increase in the overdraft.
- Director 3 believes that issuing another bond would be the best choice. He thinks that having it for 3 years would fit in with the timeline of the new investment.
Requirements:
- 1) Calculate the Theoretical Ex Rights Price after the rights issue requested by Director 1.
- 2) Explain the practical aspects which should be considered when deciding to choose between issuing debt and equity in a company and apply those to the viewpoints of each of the directors and the company's scenario.
- 3) Discuss the belief that issuing trade bonds will decrease the Weighted Average Cost of Capital (WACC) and therefore increase the market value of NewHorizons Plc. Your discussion should encompass both the question scenario and Capital Structure Theories.
4) Director 1 also put forward the view that the cost of equity of a company should be calculated using the Capital Asset Pricing Model (CAPM) or the Dividend Valuation Model (DVM).
5) Critically discuss, with reference to relevant literature, the advantages and disadvantages of both CAPM and DVM in calculating the cost of equity of a company and conclude which you feel is the better choice.
Financial and Managerial Accounting the basis for business decisions
ISBN: 978-0078111044
16th edition
Authors: Jan Williams, Susan Haka, Mark Bettner, Joseph Carcello