Question

Rights issue. micro-Electronics Corporation (mEC) has just announced that it will issue 10 million shares of common stock through a rights issue at a subscription price of $20. Before the announcement, mEC shares were trading at $26, and there were 50 million shares outstanding.

a. How many rights will mEC grant to its existing shareholders?

b. How many rights will an investor need to buy one new share?

c. What will happen to mEC’s share price when the rights issue is announced?

d. What should be the value of one right?

Answer 1

Current outstanding Shares = 50 miilion shares

Right Shares = 10 miilion shares

Ratio of rights issue = 1: 5 (one share for five shares held)

(a) mEC will grant right its existing shareholders on one for five bases.

(b) Each shareholder will be granted one right for every five shares. So for each right share, he/she will have to exchange one right.

(c) When the rights issue is announced the market value of the shares will decrease.

Issuing new shares by rights issue cause a dilution in the current profits. The profit will have to be divided by more shares. Since the Earning per share decreases, the share value also decrease.

(d)Value of one right (Theoretical Ex Right Price) : =

Current Share Price * No of o/sing shares) + ( value of right share * No of right shares issued ) / Total number of shares

Current Share Price = $ 26

Subsciption value of right share = $20

No of outstanding shares = 50 (million)

No of right shares issued = 10 (million)

= (26 * 50) + (20 * 10) / (50 +10)

= 1300 + 200 / 60

= $25 per share