Suggested solutions to homework questions Topic 5

Question 1 HSBC
PART A: Why do you think the Company is doing this?

HSBC seems to be in some financial difficulty as seen by the 18% drop in profits to
$19.9bn.

It made a not so good purchase of US consumer finance business Household (which

had subprime mortgages) and took a write-down to goodwill. This write-down may
have been lenient and further write-downs might take place after the rights issue.

HSBC may be trying to plug a hole with the money raised in the rights issue this
could make it a less safe option.

If HSBC is seeking to make an acquisition (e.g. RBS) this is likely to be a good use of
the funds.

HSBC might have level 3 assets that are inflated. Once the rights issue is conducted
they may later quietly write-down these level 3 assets (e.g. take impairments).

The rights issue seems to be for a significant amount of cash (12.5 billion) and the
larger the rights issue the greater the risk.

The rights issue is underwritten by The City so it will go ahead even if there is an
not enough subscription to the rights issue.

PART B: If you were a HSBC shareholder would you take up the rights issue?
Reasons against investing:

The articles do suggest caution to the shareholders of HSBC to undertake in the rights
issue.

The shares are considered a weak hold.

If the company is intending to use the funds in order to prop up the balance sheet
this is concerning e.g. perhaps the write-down of goodwill was not enough for the
US venture or there are level 3 assets that will be written down once the rights issue is
successful.

As an investor is participating in the rights issue going to make you money? As a

shareholder you already have shares in HSBC. Do you have more funds to go into this
same investment? You might prefer a diversified portfolio.

Reasons for investing:

If a shareholder does not undertake the rights issue then your shares will become
diluted i.e. the pool of equity is now greater but the firm worth the same market
capitalisation.

If HSBC invests the rights issue appropriately (e.g. purchases the Asian arm of RBS)
then they will likely generate future cash flows in turn increasing the share price.

Therefore, undertaking the rights issue may make money for the shareholders.

The HSBC rights issue is underwritten so will go ahead regardless of whether all
shareholders participate in the rights issue. This removes the risk of failure of the
issue.

QUESTION 2 - Final Exam, 2012, semester 1 (modified)

PART A:

Dividend payable

c/b

Shareholders Equity (in 000s)

160
165
o/b
780
Profit
45
Revaluation upwards
Share issue
950 120
1,110 1,110

Closing balance of Shareholders Equity = $950,000

PART B:

Dividend payable
c/b

c/b

Share Capital (bonus issue)

c/b

Retained Profits
c/b

Retained Earnings (in 000s)

160
40
o/b
780 Profit
675
15 General Reserve
835
835
Share Capital (in 000s)
100
o/b
120 Application (share issue)
270
50 Revaluation Reserve (bonus issue)
270
270
Revaluation Reserve (in 000s)
50
5 o/b
0
45 Assets
50
50
General Reserve (in 000s)
15
20
o/b
5
.
20
20

Balances:
Balances at
1/7/2015

Balances at
30/6/2016
2

Retained Earnings
Share Capital
Revaluation Reserve
General Reserve
Total Shareholders Equity

$000s
40
100
5
20
$165

$000s
675
270
0
5
$950