Question

Polecat plc has 18 million $0.50 ordinary shares in issue. The current stock market
value of these is $1.70 per share. The directors have decided to make a one-for-three
rights issue at $1.25 each. Julie owns 3,000 Polecat ordinary shares.
Assuming that the rights issue will be the only influence on the share price: 
(a) What, in theory, will be the ex-rights price of the shares (that is, the price of the
shares once the rights issue has taken place)?
(b) For how much, in theory, could Julie sell the ‘right’ to buy one share?
(c) Will it matter to Julie if she allows the rights to lapse (that is, she does nothing)?

Answer 1

(a) Ex right price of share

Theoretical ex-rights price (TERP) is a situation where the stock and the right attached to the stock is separated. TERP is a calculated price for a company's stock shares after issuing new rights-shares with the assumption that all these newly issued shares are taken up by the existing shareholders.

  Generally, the TERP will be lower than the pre-offering market price immediately following the rights issuing period.

Formula

TERP = [(cum right price of shares*number of existing shares) + (price at which right share are issued* number of share issued in exercise of right)] / number of share prior to right issue + number of share issued in exercise of right

TERP = [(1.7*18) + (6*1.25)] / 18+6

= $1.5875

(b) Julie can sell the right to buy one share at the value of right which is

Value of right = TERP - Price at which rights are issued

i.e, $1.5875 - $1.25

i.e, $0.3375

(c) Yes it definitely will matter to Julie if she doesn't take any action. Let's see how

Julie's wealth before right issue = 3000*1.7 i.e. $5100

Julie's wealth after right issue = 3000*1.5875 i.e. $4762.5

Reduction in Julie's wealth = $337.5

Julie will lose the value of right if she let the right to lapse.