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ACCA Strategic Professional · Advanced Financial Management · Financing acquisitions and mergers

Gamma plc is choosing between funding a cash takeover through a rights issue or new debt. Which is the most valid reason a rights issue may be preferred?

A rights issue may be preferred because it raises equity rather than debt, so gearing and fixed interest obligations do not increase. Equity is still costlier than debt, and EPS can be diluted by the extra shares, so those other statements are wrong.

  1. AIt avoids increasing financial gearing and fixed interest commitmentsCorrect
  2. BIt always has a lower cost than debt because dividends are discretionary
  3. CIt removes the need for shareholder approval
  4. DIt prevents any dilution of earnings per share

Explanation

A rights issue adds equity, so gearing and fixed interest obligations do not rise, reducing financial risk. Equity is not cheaper than debt, and a rights issue increases share count so EPS can be diluted.

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