Question

Berry Ltd is a public retail company that is currently expanding their operations. In order to do this, the directors need a substantial injection of cash to finance the new development. The option for cash injection is by issue of share or/versus issue of debentures. Required: You have been asked as the graduate accountant, to prepare a report to the board of directors summarising the effects each choice would have on the financial statements, and what financial commitments the company would be liable for under each option. Please help with answer for each option.

Answer 1

Answer)

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Report to the Board of directors of Berry LTD:

Overview:

This is an report summarising whether to choose Issue of Shares or Debenture for cash injection.

Impact on financial Statement:

(a) Issue of Share:

Issue of shares would rise the share holders equity with definite effect on share capital and increase of reserves if such shares are issued for premium. The cash so received will increase cash balance and from it will be routed to necessary project account. However, this may lead to fall or rise of EPS which is need to be verified before issual to avoid adverse effect in financial markets.

(b) Issue of debentures:

Issue of debentures will increase long term debt and at the some time increase in cash balance from where it is routed to necessary project account. Due to issue of debenture there will be need of compulsory payment of interest which may lead to change in net profit either increase or decrease which is a point to be considered before issual.

Financial commitment needed to be given:

(a) To the share holders:

The share holders may loose their share due to issual of the new shares and hence first share should be offered to existing shareholders only. Moreover the project benefit should be at least current net profit percentage considering the increase in shares to avoid fall of EPS. If there is further growth strategy, it is better to issue shares as there is no commitment needed for fixed payment.

(b) To the debenture holder:

The interest rate is compulsory amount to be paid regardless the profit earn and hence it should be considered. If the new project is expected to increase cash definitely and increase share holders wealth then it is better to issue debentures as Cost of debt will be lower as compared to cost of equity.