Question

and Sons Ltd are considering expanding their operations. Several alternative strategies are being discussed for financing this expansion. The latest balance sheet of the company as t 31 December 2015 is as follows: and Sons Ltd Balance sheet at 31 December 2015 K K Non-Current assets Land and buildings 40,000 Plant and equipment 90,000 130,000 Current assets Inventory 50,000 Debtors 40,000 Cash 5,000 95,000 Creditors: amounts falling due within one year 25,000 Net current assets 70,000 Total assets less current liabilities 200,000 Creditors: amounts falling due within one year: 12% loan repayable 2021 90,000 110,000 Share capital and reserves K 8% cumulative preference shares of K1 each 30,000 Ordinary shares of K1 each 50,000 Income statement 30,000 110,000 The board of directors has identified the following possible alternative ways of obtaining the additional K50,000 required during the following year.: (a) Issue additional ordinary shares (b) Issue additional 8 per cent preference shares. (c) Raise an additional long-term loan at 12 per cent. Discuss the company’s existing capital structure in terms of its gearing, and examine the advantages and disadvantages of each alternative method of financing its expansion plan.

Answer 1

*Answer:

SIchula and sons ltd has its capital structure -

• Equity shares
• Preference share
• Long term debt

And its gearing ratio is = Long term debt / capital employed

= 90000 / 200000

= 0.45

Company has high volume of fixed bearing fund which inclues long term debt and preferece share capital due to this Earning per share is less but tax saving is availabe with interest on long term debt. and capital gearing ratio is balanced.

Here company need $ 50000 and company arrange this fund from alternative ways:

Altarnative	Equity share	Debt	preference share
Advantages	No Repayment Requirement unless buyback	Tax savings would be availabe to company on interest paid on new debt amount	improve borrowing capacity to use the alternative
	lower risk as compare to other option	Maintaining of company ownership	no dilution in control
	sharing of ownership as partner	maintainance of ratios
Disadvantages	Ownership dilution may result in decrease in EPS	Repayment of interest and principal	Reduction in EPS
	Higher cost than others	impact of credit rating	burdon on company

As per these consideration debt is best in tax advantage and equity is best in maintaining EPS.

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