Tope operates a chain of cellular telephone stores in the country. An abbreviated profit or loss account and statement of financial position of the business for the year that has just ended is as follows:
Abbreviated Profit or Loss Account for the Year Ended 31 May 2023
| Item |
Amount (₦’000) |
| Sales |
6,450 |
| Operating profit for the year |
800 |
| Interest payable |
(160) |
| Net profit before taxation |
640 |
| Tax (20%) |
(128) |
| Net profit after taxation |
512 |
| Dividends proposed |
(256) |
| Retained profit for the year |
256 |
Abbreviated Statement of Financial Position as at 31 May 2023
| Item |
Amount (₦’000) |
| Non-current assets at written down values |
3,500 |
| Current assets |
1,800 |
| Less: Current liabilities |
(1,100) |
| Net Current Assets |
700 |
| Total Assets |
4,200 |
| Less: Long-term liabilities |
(2,000) |
| Net Assets |
2,200 |
| Capital and Reserves |
|
| ₦0.50 ordinary shares |
600 |
| Retained profit |
1,600 |
| Total Capital and Reserves |
2,200 |
The company is expecting a surge in sales following advances in cellular telephone technology that should translate into additional operating profits of ₦180,000 per year for the foreseeable future. However, the company will need to invest ₦1,200,000 immediately in expanding the asset base of the business if it is to achieve these additional profits.
The business has approached a large supplier that already has an equity investment in the business to see whether it would be prepared to provide further funds for the business. The supplier has indicated it would be willing to provide the necessary funds by either:
(i) An issue of ₦0.50 ordinary shares at a premium of ₦1.50 per share; or
(ii) An issue of ₦1,200,000 10% debt at par.
The Board of Directors of Tope has already announced that it will maintain the same dividend payout ratio in future years as in the past, and that this policy will be unaffected by the form of finance raised.
Required:
a. For each of the financing options: i. Prepare a forecast profit or loss account for the forthcoming year. (5 Marks)
ii. Calculate the forecast earnings per share for the forthcoming year. (2 Marks)
iii. Calculate the projected level of gearing (D/(D+E)) at the end of the forthcoming year. (2 Marks)
b. Calculate the level of operating profit at which the earnings per share will be the same under each financing option. (3 Marks)
c. Evaluate each of the financing options from the viewpoint of an existing shareholder. (2 Marks)
d. Discuss the factors that will influence a company to finance through debt or equity, and whether to opt for long-term or short-term debt. (6 Marks)
(Total: 20 Marks)
