Question

You are a shareholder in XViti Limited. XViti Limited’s shares are trading in the market at $7.50. XViti Ltd today announced a renounceable rights issue offer which provides you with a right to subscribe for one new share at $6.50 for each four shares that you hold.

a) Explain the effect of the offer being renounceable and consider one of the shareholders' perspectives in this rights issue and develop an argument for why it should be the most important/credible option for a shareholder.

b) Calculate the price of the right.

c) Calculate the theoretical ex-rights share price.

Answer 1

(a)

Right issue is different from the ''renounceable rights issue''.

-Under Right issue, there is a offer to he existing shareholders to subscribe to the new capital at adiscounted price.

-Under ''Renounceable rights'', the owners of the rights have the following options-

(1)Exercise the right and purchase the new share

(2) Sell the rights on the market

(3) Do nothings and let the Right expire.

-Offer being renounceable means the right can be sold for cash by the share holder.

-Under ''renounceable rights issue'' either he can purchase the share or sell the rights for cash or else ignore the right and let it be expire.

-For Example one share holder Holds 4 shares and got one right to buy one share at $6.50

Now wealth of the share holder before right issue = $7.50 per share * 4 share = $30.

After the Right share issue, his wealth of 4 share will be = Theoritical Ex-right price * 4 share=$7.30* 4 = $29.20.

Note-Theoritical Ex-right price hs been calculated at point ''c''.

Scenario	Before right issue wealth	After right issue wealth	Remark
If choose to buy the right share	$7.50*4 =$30	[$7.30*5]-$6.50 = $30	Buy one share at $6.50. hence total share in hand will be 5, after right issue
If choose to sold the right or renounce the right	$7.50*4 =$30	[$7.30*4]+$0.80 = $30	By selling the right the share holder will get $0.80. (Note-value of right is calculated at point ''b'')
If choose to do nothing	$7.50*4 =$30	[$7.30*4]= $29.20

-From the above table we can understand that renounceable right is most important/credible option for a shareholder as he can sell the right to get cash, so that his over all wealth will not decline post right issue.

(c)

Right = 1 for every 4 shares hold

Theoretical ex-rights share price =[ $7.50*4 + $6.50*1] / (4+1)

=>Theoretical ex-rights share price = $7.3

(b)

price of the right. = [Pre Right price-Exright price]* Number of shares

=>price of the right.= [$7.50-$7.30]*4 = $0.80