Page 334 - Microsoft Word - 00 CIMA F1 Prelims STUDENT 2018.docx

Chapter 12

Example 4

A business is looking to raise $2 million for a new project and wants to raise
the funds with a rights issue.

The current market price for its shares is $5 and it wants to set the rights issue
price at $4. It currently has 2 million shares in issue and will raise funds using
a 1 for 4 issue.

Required:

What will be the yield adjusted TERP if the yield on the new funds is 14%
but the yield on existing funds is only 12%?

Solution

Yield adjusted TERP =

[(N × cum rights price) + (issue price × Y new/Y old)]/(N + 1)

TERP = [(4 × $5) + ($4 × 14/12)]/(4 + 1)

TERP = [$20 + $4.67]/5 = $4.93 per share

An alternative way of looking at this is to say that the 1 new share in every 5
will be worth $4 × 14/12 = $4.67 and the old shares remain at their existing
value of $5. The values average out to $4.93.

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