Question

ABC Company is considering raising $70 million through a rights issue. It has 40 million ordinary shares outstanding, currently selling for $10 each. The subscription price of new shares will be $7 per share.

a. How many shares must be sold to raise the desired funds?

b. How many shares must a shareholder own in order to have one right?

c. What is the theoretical value of the shares ex-rights?

d. What is the value of one right?

Answer 1

Solution:
a.	No. of shares must be sold to raise the desired funds		10,000,000 shares
Working Notes:
	No. of shares must be sold to raise the desired funds = Amount to be raised / Subscription price
		=70,000,000/$7
		=10,000,000
		=10 million
b.	Shares must a shareholder own in order to have one right		4 shares
Working Notes:
	Shares to have one right = No of old shares / No of new shares to be issued
		=40,000,000/10,000,000
		= 4 shares
	4 shares required to have 1 right
c.	The theoretical value of the shares ex-rights	$9.40
Working Notes:
	Stock ex-rights = [n x ROP + SP] /(n+1)
	n= no. of Rights required to buy a Right share= 4
	ROP = Right on price or Cum-Right price = $10
	SP = Subscription price = $7
	Stock ex-rights = [n x ROP + SP] /(n+1)
	=[4 x 10 + 7 ] /(4+1)
	=[47]/5
	=47/5
	=$9.40
d.	Value of a right	$0.60
Working Notes:
	Value of a right = ROP - Ex Right price
	ROP = Right on price or Cum-Right price = $10
	Ex-rights price                           =$9.40	as calculated in c.
	Value of a right = ROP - Ex Right price
	= $10 - $9.40
	=$0.60
Please feel free to ask if anything about above solution in comment section of the question.