a) Rights issue

A rights issue is an issue of new shares for cash to existing shareholders in proportion to their existing holdings.

Convertible loans

A convertible loan (or bond) is a loan stock that can be converted, at the option (but not the obligation), of the holder (i.e. the lender) into ordinary shares of issue (i.e. the borrower) on or before the maturity of the loan.

b) The theoretical ex-rights price is computed as follows:

N

5 existing shares@N3 = 15.00

1 new share@N2.50 = 2.50

6 17.50

Ex – right price N17.50/6 = N2.92

The actual market value of the shares may be different from the theoretical price for the following reasons:

 The existence of specific information (positive or negative) regarding the company or its sector at the time of the issue;  The information regarding the use to which the proceeds will be put and the market’s reaction to that information; and  The expectations of investors/ the stock market regarding the company’s future.

c) REPORT

To The Board of Balama Plc

From Goodhead Kay, Financial Consultant

Date 16 November 2022

Subject Financing expansion plans

Rights issues

For an established listed company, rights issues are much more popular for the following reasons:

 Rights issues are relatively cheap to make, perhaps less than half as expensive as a public issue;  The issue price is relatively unimportant. Since all existing shareholders benefit from the cheap price in proportion to their shareholding, there is no disproportionate gain. The company needs to make the rights price significantly cheaper than the market price. This puts pressure on shareholders to take up the shares or to sell them to an investor who will. Thus, rights issue tends not to fail, i.e. the shares tend to be issued, and the required cash raised;  Control tends to stay with the existing shareholders.

 The need to discount the offer price to ensure that the issue is fully subscribed and to cover the possibility that the market price of shares might fall between the announcement of the rights issue and its conclusion; and  The use of rights issue leaves the credit line free to finance further expansion and enables the non-current assets to be used to secure other lines of finance, if required.

It seems as if a rights issue would provide a cheaper and more practical way for the company to raise the funds for the expansion.

Convertible loan stock issue

Convertibles are a mixture of loan and equity financing. They are issued as loan stocks with the right to convert them into equity shares of the same company at some pre-determined rate and date.

From the investors‟ point of view they are relatively safe, in that there is a close-to guaranteed interest payment periodically and a right to convert to equity, if it is beneficial to do so.

From the company’s viewpoint they are attractive because:

 Cheap to issue: Loan stock is generally cheap to issue, so it becomes, if all goes well, a cheap way of issuing equity;  Loan finance is relatively cheap to service because of the tax-deductibility of interest charges; and

 They are self-liquidating, provided the holders convert, the loan liquidates itself through an equity issue, which saves the company the problem of raising the cash to replace the expiring loan stock.

Disadvantages of any type of loan financing include:

 The likely need to provide security for the loan; and                                                                                                                                           The possibility that lenders will impose covenants, for example, restricting the level of dividends and/or insisting on a minimum liquidity ratio.

Raising finance, unless it is from a mixture of debt and equity, will affect the level of gearing, with probable implications for the risk/return profile and the cost of capital.