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Answers

Example 6

JJ Co has in issue 1.2 million shares, currently valued at $3 each, and a rights
issue is being considered.

The rights issue will be either:

 1 for 4 at $2.50 per share, or

 1 for 3 at $1.875 per share.

Assuming that all shareholders take up their rights, and that there are no
issue costs, what will be the effect of the rights issue on each
shareholder's total wealth before taking account of any positive NPV
generated by investing the new capital?

A Total wealth increases more under the 1 for 4 scheme

B Total wealth increases more under the 1 for 3 scheme

C Total wealth is unchanged under both schemes

D Total wealth decreases under both schemes

Solution

The answer is (C).

Total wealth is always unaffected by the rights issue itself. Wealth only
changes as a consequence of the NPV generated by any project invested in.

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