Question 1.A.1: Pointon Ltd has the following long-term capital and annual p...
Pointon Ltd has the following long-term capital and annual profits:
Capital invested (£1 ordinary shares) £100,000
Profit available to ordinary shareholders £ 15,000
The business is considering the issue of 20,000 new £1 ordinary shares and investing the amount raised in an opportunity that provides an additional profit of £2,000 for ordinary shareholders.
What should be done if the objective of the business is to maximise:
(a) profit available to ordinary shareholders?
(b) profit available to ordinary shareholders per ordinary share?
The profits available to ordinary shareholders will be increased by the investment to
£17,000 (£15,000 + £2,000).
The profit per ordinary share, however, will be decreased. The current profit per ordinary share is 15 per cent (£15,000/£100,000) whereas the expected profit per ordinary share on the investment is 10 per cent (£2,000/£20,000). The effect of taking the opportunity will, therefore, be to lower the overall profit per ordinary share to 14.2 per cent (£17,000/£120,000).
We can see that an objective of maximising profit available to shareholders would lead to a decision to invest, whereas an objective of maximising profit available to shareholders per ordinary share would lead to a decision to reject the opportunity.