Question

Leads and Plugs Limited manufactures electrical wiring and plugs for consumer electrical goods. The Chief Executive, Eddie Smith is a very hands-on head of the business. He left school aged 16 and trained as an engineer with the company and is very knowledgeable about all operational aspects of the business. He is even known to turn his hand to helping in the assembly line if there are staff shortages, for example if there is a period during the winter where there is staff shortage due to colds and flu viruses.

However, Eddie is not so good at dealing with paperwork, much to the Administrative and Accounting Department’s dismay. This year he has promised to help them progress a number of Administrative and Financial matters. The first of these concerns a new Bond which Leads and Plugs has bought. Eddie made the decision to buy this on recommendation from a business associate. Eddie has managed to find some paperwork about this at the bottom of his filing cabinet. He has had a look at it but it is making him quite nervous as he does not understand it at all. Louise in Accounts has asked him for some key pieces of information. He has jotted some of these down as follows:

Length of term of the bond: 12 years

Par value of the bond: £100

Coupon: £3 semi-annually

In addition, he has noted from a meeting with the firm’s Financial Advisors that the “yield to maturity” of this type of bond is 8%.

The Financial Controller, Jeff, has also mentioned to Eddie that the company should be thinking about having a bonus or rights issue of shares. This is also making Eddie nervous as he does not understand what either of these terms mean and what the difference between each is. He is keen to make shares more attractively priced to the new investor and also to maintain existing investors’ interest in the company. However, he is not concerned about the company’s cash position as the credit control team has successfully improved the cash position in the business over the last few years. He is really struggling to figure out what the effect on the financial statements would be and Jeff has been too busy to explain this to him.

Eddie has looked out the last Financial Statements and has picked up the following information. He wonders if this might be useful.

Number of Ordinary Shares currently in issue: 12 million

Balance on retained earnings: £25million

QUESTIONS - Jeff is very busy preparing some information for the Company Bank. Jeff has asked you, as his assistant, to help him by drafting the following information for Eddie.

a) Prepare notes which explain to Eddie what the key differences between a bonus and a rights issue. Jeff mentioned you could consider, for example, the motivation for the issue, whether cash changes hands, who the shares are offered to and the effects on the financial statements.

Also, Jeff is considering whether Leads and Plugs Limited should have a bonus issue of shares. The terms would be that 4 new shares would be issued for every 3 shares held.

Jeff would like to you calculate how many new shares would be issued.

                                                                                            

b) Lastly, prepare a note for Louise who has asked you to calculate the price of the coupon bond. She has also asked that you explain whether this bond is selling at a premium or a discount.

Answer 1

a) Both Right shares and Bonus share are issued to existing shareholders.Following are the key differences:

Right Shares	Bonus Shares
1. Issued at a price lower than market price.	1. Issued free of cost
2.It effects cashflow of the entity.	2. No impact on Cashflow of the entity.
3.It involves increase in Equity (Equity share capital + other equity)	3.Equity remains same post Bonus issue.
4.It may be Fully paid up or partly paid up.	4.Always fully paid up.
5.These shares have Right to Renounce.	5.No such right.
6.Raises additional capital from market.	6.Bonus shares are issued out of Free Reserves
7. Increase in Capital, Increase in Cash balance and debit to Profit & loss a/c to the extent discount offered.	7.Increase in share capital and decrese in other equity.

Calculation of New shares to be issued:

Existing No. of utstanding shares = 12Million

Bonus Ratio = 4 shares for every 3 shares held

New shares to be issued = 12M * 4/3 = 16Million shares

b) Calculation of Price of Bond:

Therefore we can conclude that Bond is selling at discount as the price is lower compared to its Par value.