which option the company should choose to raise the funding

| November 9, 2018

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.

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