Question

ABC Inc currently has 500,000 shares outstanding at $44 each. The company is proposing a rights offering with subscription price set at $35. Shareholders will need to have four rights to exercise their right to buy each new share.

I. What is the new market value of the company after the rights issue?

II. What is the value of each right? What is the ex-rights price of shares?

III. ABC managers want the ex-rights price to be $42.80. What should the subscription price be to ensure the desired ex-rights price?   

IV. Why is ABC Inc having a rights offer than a general cash offer to raise new funds?

Answer 1

1-
existing value of shares	no. of shares outstanding*market price	500000*44	22000000
value of shares issued under right issue	(500000*1/4*35)		4375000
value of company after the right issue			26375000
2-
value of a right	(market price-right price)/no. of rights required to buy a share	(44-35)/(4+1)	1.8
Ex right price	market price-value of right	44-1.8	42.2
3-
What should the subscription price be to ensure the desired ex-rights price	ex-right price = market price-value of right	42.8=44-value of right	value of right =44-42.8	1.2
value of right	(market price-right price)/no. of rights required to buy a share	1.2 =(44-subscription price)/(4+1)	Subscription price = 44-6	38
4-
ABC offered a right issue because right offer results in no dilution of control and required funds can be arranged with the dilution of control and it is preemptive right of existing shareholders