Solved: Netherby plc manufactures a range of camping and

leisure equipment

Netherby plc manufactures a range of camping and leisure equipment, including tents. It is
currently experiencing severe quality control problems at its existing fully depreciated factory in
the south of England. These difficulties threaten to undermine its reputation for producing high-
quality products. It has recently been approached by the European Bank for Reconstruction and
Development, on behalf of a tent manufacturer in Hungary, which is seeking a UK-based trading
partner which will import and distribute its tents. Such a switch would involve shutting down the
existing tent manufacturing operation in the United Kingdom and converting it into a distribution
depot. The estimated restructuring costs of £5 million would be tax-allowable, but would exert
serious strains on cash flow.

Importing, rather than manufacturing, tents appears inherently profitable, as the buying-in price,
when converted into sterling, is less than the present production cost. In addition, Netherby
considers that the Hungarian product would result in increased sales, as the existing retail
distributors seem impressed with the quality of the samples which they have been shown. It is
estimated that for a five-year contract, the annual cash flow benefit would be around £2 million
p.a. before tax.

However, the financing of the closure and restructuring costs would involve careful
consideration of the financing options. Some directors argue that dividends could be reduced,
as several competing companies have already done a similar thing, while other directors argue
for a rights issue. Alternatively, the project could be financed by an issue of long-term loan stock
at a fixed rate of 12 per cent.

The most recent Balance Sheet shows £5 million of issued share capital (par value 50p), while
the market price per share is currently £3. A leading security analyst has recently described
Netherby's gearing ratio as 'adventurous'.

Profit after tax in the year just ended was £15 million and dividends of £10 million were paid.

The rate of Corporation Tax is 33 per cent, payable with a one-year delay. Netherby's reporting
year coincides with the calendar year and the factory will be closed at the year end. Closure
costs would be incurred shortly before deliveries of the imported product began, and sufficient
stocks will be on hand to overcome any initial supply problems. Netherby considers that it
should earn a return on new investment of 15 per cent p.a. net of all taxes.

Required

(a) Is the closure of the existing factory financially worthwhile for Netherby?

(b) Explain what is meant when the capital market is said to be information-efficient in a semi-
strong form.

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 If the stock market is semi-strong efficient and without considering the method of finance,
calculate the likely impact of acceptance and announcement of the details of this project to the
market on Netherby's share price.

(c) Advise the Netherby board as to the relative merits of a rights issue rather than a cut in
dividends to finance this project.

(d) Explain why a rights issue generally results in a fall in the market price of shares. If a rights
issue is undertaken, calculate the resulting theoretical ex-rights share price of issue prices of £1
per share and £2 per share, respectively. (You may ignore issue costs.)

(e) Assuming the restructuring proposal meets expectations, assess the impact of the project on
earnings per share if it is financed by a rights issue at an offer price of £2 per share, and loan
stock, respectively. (Again, you may ignore issue costs.)

(f) Briefly consider the main operating risks connected with the investment project, and how
Netherby might attempt to allow for these.

Netherby plc manufactures a range of camping and leisure equipment

ANSWER
https://solvedquest.com/netherby-plc-manufactures-a-range-of-camping-and-leisure-equipment/

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