Texts: Orion plc is an all-equity company with 240 million shares issued and a current share price of £5.60. Having just received and reviewed its preliminary results for the year ended 31 March 2022, the directors have decided to invest heavily in new technology. This will require immediate long-term financing of £112 million. The funds can be raised by one of two ways, either by a one-for-six rights issue at a deep discounted price of £2.80 per share, or by taking out a 15-year debenture for the same amount. The debenture will cost £15 million (gross) in interest each year. If the rights issue option is taken, the Price Earnings (PE) ratio is expected to remain at 14 times, while if the debenture issue option is taken, the PE ratio is predicted to decline to 13 times.
For the year ending 31 March 2023, the company predicts a substantial growth in operating profits (EBIT) to £180 million based on the benefits of the new investment and the improving trading conditions. Operating profit for the year ended 31 March 2022 was £120 million. The company does not intend to make dividend payments during the year. Assume a corporation tax rate of 20%.
Questions:
a) Assuming a rights issue of shares is made, calculate:
i. the theoretical ex-rights price of an ordinary share in Orion plc.
ii. the theoretical value of the rights for each original ordinary share.
b) Estimate the price of an ordinary share in Orion plc on 31 March 2023 assuming:
i. a rights issue was made during the year.
ii. a debenture issue was made.
c) Calculate the breakeven operating profit for a shareholder to be indifferent between the two methods of raising the required long-term capital.