2020 BPGH S4O/5N P2 Q4 Miracle Limited

2020 BPGH S4O/5N P2 Q4 Miracle Limited

Miracle Limited is a company that trades in face masks and other pharmaceutical products The company would like to raise funds for further expansion of its existing business. Miracle is considering taking out a 4% bank loan, $120,000, on 1 July 2019. The loan is repayable in 5 equal instalments, payable on every 30 June. Interest is payable each year calculated on the amount of the loan outstanding over the year on 30 June.

REQUIRED

a. Assuming that Miracle Limited decides to take out the loan on 1 July 2019, calculate the interest expense to be shown in the income statement of financial performance for the year ended 31 December 2020. 

[2]

b. The company accountant suggests that Miracle Limited could issue new shares of $120000 instead of taking out the loan to raise the necessary funds. Assuming that Miracle Limited decides to issue the new shares on 1 July 2019, state the double entry to record the issue of new shares. Narrations are not required

[2]

c. Compare and comment on the above two options of raising funds. Advise Miracle Limited on which option it should take. 

[6]

[TOTAL 17]

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Make a Decision

BORROW

ISSUE SHARES

Make a choice and state your decision clearly.

I advise Miracle to borrow from the bank

I advise Miracle Ltd to issue shares to raise funds

   

Supporting Evidence & Explanation

Any Two Points

Any Two Points


When supporting your decision, you will have to:


  • Extract the relevant evidence from the question; and

  • Explain why the evidence supports your decision

- When Miracle borrows, he agrees to pay the bank interest in exchange for using their money. The bank don't own a piece of his business and they don't participate in his decision-making.


- Hence, there is no dilution of control.


- Borrowings also offer the advantage of allowing Miracle to borrow money only for the time he will need it.

- If he keeps the long term as short as possible, it will save him money by limiting the amount of time he pay interest

- The interest is tax-deductible as an expense for Miracle’s company.




- Issuing share capital gives you the advantage of not owing any money to the bank, because you are not borrowing. He don't have to make any payments for the money he  raise this way.

- Miracle must pay interest on loan to the bank, which differs from dividends that he has to to pay when he declares one. The interest must also be paid according to a strict timetable, which can create problems if the business is not performing well.
- Since equity financing is a greater risk to the investor than debt financing is to the lender, the cost of issuing share is often higher than the cost of debt



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