IntroductionKoala Ltd is a large blue chip Australian diversified industrial company and first...

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IntroductionKoala Ltd is a large blue chip Australian diversified industrial company and first listedon the Oldcastle Securities Exchange in 1994. As a diversified industrial the companyoperates within sectors including retail, resources and financial services. In the mid2000’s the company experienced a period of high growth and great success, andtook advantage of this success by making several large takeovers of competitors.The company has 25,000 shareholders who own on average 200 shares in thecompany each, and the current share price is $33.10 per ordinary share. Themajority of Koala Ltd’s shareholders are Australian residents for tax purposes. Thecompany’s debt ratio is currently 46%.Recently there has been significant change both at the company and within sectorsthat the company operates in.The CEO of the last 15 years has retired and a new CEO has been appointed who isstill trying to “find his feet” at the company and has been asking a lot of questions ofthe finance manager.The retail industry has experienced slowing sales growth as online shoppingincreases in popularity. The board of directors of Koala Ltd have decided that itwould be a good time to commence selling their retail products online in addition toselling through current retail outlets. They have identified a company that is anonline retailer in direct competition with Koala Ltd’s retail business that they willcommence takeover proceedings to acquire.The company needs to raise a minimum of $20,000,000 to finance the acquisitionand cover the acquisition-related costs. The finance manager has identified severaloptions to raise the required funding. These options are mutually exclusive so thecompany must select only one option.Option 1: a rights issueThe finance manager is aware that a rights issue could be used to raise the fundingrequired for this acquisition. The rights would be non-renounceable. Afterconsultation with the legal advisors the finance manager has learned that adisclosure document (not as detailed as a full prospectus) would be required for thisrights issue. The cost of this disclosure document is significantly lower thanpreparing a full prospectus.The rights offer being considered is a 1 for 5 issue with a subscription price of$26.50 per share. The company expects 75% of existing shareholders to subscribeto the issue. The company does not intend to use the services of an underwriter forthis issue.Page 4 of 6Option 2: issue corporate bondsThe company can make a new issue of corporate bonds in order to raise therequired funds. The finance manager has been advised by the credit rating agencythat the rating given to the issue would be “BB”.The corporate bonds that would be issued would be 10 year bonds with a face valueof $1,000 per bond paying interest at a rate of 8% per annum payable half yearly.In appendix 1 you will find the current market yields for bonds of various creditratings.Option 3: issue ordinary sharesThe company can make a new issue of ordinary shares in order to raise the requiredfunds.Koala Ltd just paid a total dividend of $2.45 per ordinary share this year. Thisdividend will increase at 10% for the next 4 years, and then the growth rate willdrop to 7% per year indefinitely.The required rate of return on ordinary shares is currently 18% per annum.Required:You work for an investment bank, Lake Macquarie Bank, and have been employedas a consultant to the CEO of Koala Ltd to help with this important funding decision.You must write a report of maximum 2,500 words to the new CEO of Koala Ltdregarding the 3 options identified by the finance manager for raising the minimum$20,000,000 necessary for the upcoming acquisition.In your report you must discuss the advantages and disadvantages of each optionand the implications for current shareholders and current debt-holders (see themarking criteria for more specific requirements). You must also make an overallrecommendation as to which option the company should choose to raise the fundingrequired for the acquisition. You must explain why this is an appropriate choice.

David · Accepted Answer

Analysis of Option 1 
 
The basic concern of a company CFO is how to raise around $20000000. They only search 
for the opportunity, they don’t care whether the investment is international or national, totally 
financial or it is on the factories of outside the country. There are many factors which 
sometimes affect the choice of the company to raise this money. One of the options is to go 
with the right issue which means to raise the capital by issuing the shares to the existing 
shareholders in the ratio of 1:5 with subscription price of 26.5. It can be found by multiplying 
the total no. of existing shareholders with ratio of 1:5 and then 75% of subscription rate to 
find the no. of shares. Finally, it is multiplied with 26.5 to get the total required amount. The 
total amount that can be raised with this option is as follows:- 
Subscription price 26.5 
No. of existing shareholders 25000 
Average no. of Shares/ 
Shareholder 200 
Total shares 5000000 
No. of rights’ issued 1000000 
Average Subscription 0.75 
Total amount raised 19875000
Hence, this option will help to raise around 19.875 million out of required 20 million for the 
expansion.  Besides these it has many other advantages which can be explained in the 
following sections. 
Advantage over IPO listing 
 
Right issuance is better than IPO since it always suffer from underpricing. It is because a 
common goal in setting the price for an IPO is to ensure that demand for the shares exceeds 
supply, so that there is a “pop” in the share price on the first day of trading. Hence, the share 
is under price as per various empirical studies.  Therefore, investment banks must strike a 
balance between offering a company at a low enough price to stimulate demand, while also 
ensuring that the company generates sufficient capital.  Besides these it has many other 
advantages over the equity issuance which can be described as follows:- 
1) Going for equity options means you are diluting more & more percent of promoters’ 
ownership. 
2) The company will have to make more information available for the public if it will 
select equity options because of change in tax structure for dividend payments. 
3) Every company avoids payment of dividend as for investors it is a case of double 
taxation i.e. first it is tax by the corporation and then it is tax again at the hand of individual 
investors.
Hence, Going for the right is better since it can be issued with much lower cost with no fear 
of underpricing and no such issue of diluting information and all will be there. 
Advantages over Bond issuance 
 
The advantage of Right issuance over capital raised through debt is that more debt in the 
balance sheet increases the financial risk which in turn decreases the cash flow left after the 
tax payment. A small deviation in expected cash flow put the whole firm in great danger and 
may put at the brink of bankruptcy. 
Disadvantages of Right issue 
 
The biggest disadvantage associated with right issue is that sometimes it is not able to raise 
the required amount of fund necessary for the organization. It is because of this reason; 
Companies avoid going with right issues. Besides these it doesn’t provide the benefits of 
issuance with premium which in turn avoid the company to take advantage of brand image 
that they built over the years. The company is issuing right at 26.5 against the existing market 
price of 33.1 dollar per share. It also increases the costly equity in the company’s balance 
sheet and devoid it from taking the advantage of leverage.

Introduction Koala Ltd is a large blue chip Australian diversified industrial company and first listed on the Oldcastle Securities Exchange in 1994. As a diversified industrial the company operates...

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