Page 123 - Microsoft Word - 00 CIMA F1 Prelims STUDENT 2018.docx

Financing – Equity finance

Example 7

MNO is planning a rights issue at a 30% discount to the current share price, in
order to raise $7 million.

It currently has 10 million shares in issue, trading at $2.00 per share. The
directors are trying to calculate the theoretical value of a right per existing
share, so that they can inform shareholders what the likely proceeds will be if
shareholders decide to sell their rights rather than take them up.

Required:

What is the theoretical value of a right per existing share in these
circumstances?

Solution

The answer is $0.20.

An issue price at a 30% discount means $2.00 × (1 – 0.30) = $1.40

To raise $7 million using an issue price of $1.40, we need to issue 5 million
shares (i.e. $7m/$1.40). Therefore this rights issue is a 1 for 2 issue (5 million
new shares being issued and 10 million existing shares).

TERP = [(N × cum rights price) + issue price]/(N + 1)

i.e. [(2 × $2.00) + $1.40]/(2 + 1) = $1.80 and so the value of a right per existing
share is

(Theoretical ex-rights price – issue price)/N

($1.80 – $1.40)/2 = $0.20

115