In: Finance
Faff plc wants to raise $200 million in equity via a rights
issue. The company has 100 million shares in circulation and the
current share price is $9. If the company decides to hire an
underwriter to advise them on the rights issue, the underwriting
fee will be 3 percent of proceeds assuming the new shares are
offered at a 25 percent discount. However, the Chief Financial
Officer of Faff plc believes that a 40 percent discount on new
shares will avoid the need for underwriting altogether.
Set out the terms of the issue under each of the two alternatives
referred to above. Compute the theoretical ex-rights price and the
value of a right. Explain the results.
Theoretical Ex right Price =( Market Value of Equity before right shares + Value of Righ shares) / Total Number of Shares
Where, Total Number of shares = Current Outstanding Shares + Number of right shares issued
Scenario 1 : Number of Shars Befiore Right issue = 100 Millions
Price Per share = $9
So, Market Value of Equity before right shares =Number of Shars Befiore Right issue * Price Per share
= 100 Millions * 9
= $900 Millions
Value of Right Shares = 200 Millions - Underwriters Commission
= 200 Millions - (3% * 200 Millions)
= $194 Millions
Price Per shares of Right Share = Market Price of Share * ( 1 - Discount Percentage)
= 9 * ( 1 - 25%)
= 9 * 0.75
= $6.75
Number of Shares of right issue = Value of Right Shares / Price Per shares of Right Share
= 194 Millions / 6.75
= 28.740 Millions
So, Theoretical Ex right Price = (900 Millions + 194 Millions) / (100 Millions + 28.740 Millions)
= $8.49774
Value of right = Market Value of Share - Theoretical Ex right Price
= 9 - 8.49774
= $0.5022
Scenario 2: Market Value of Equity before right shares = $900 Millions
Value of Right Shares = 200 Millions
Price Per share = Market Price of Share * ( 1 - Discount Percentage)
= 9 * ( 1 - 40%)
= 9 * 0.60
= $5.40
Number of Shares of right issue = Value of Right Shares / Price Per shares of Right Share
= 200 Million / 5.40
= 37.037 Millions
So, Theoretical Ex right Price = (900 Millions + 200 Millions) / (100 Millions + 37.037 Millions)
= $8.027
Value of right = Market Value of Share - Theoretical Ex right Price
= 9 - 8.027
= $0.97297