Question

In: Finance

Instead of making an issue of stock to investors at large, companies sometimes give their existing...

Instead of making an issue of stock to investors at large, companies sometimes give their existing shareholders the right of first refusal. Such issues are known as privileged subscription, or rights issues. Shareholders own one “right” for each share they held. Shareholders could sell, exercise, or throw away these rights. The following is an example.

The Bank of Notreal will offer a rights issue to its existing shareholders in order to increase its capital base by $58,750,000. The bank will allow shareholders to subscribe to new shares at a price which is $12.97 below the current market price of the common shares. Shareholders will receive one right for every share held. The bank's partial statements are shown below:

                                    Partial Income Statement ($000)      

Revenue                                  $213,500

Interest                                        91,000

Earnings Before Tax                122,500    

Taxes (@50%)                           61,250

Earnings After Tax                    61,250    

_________________________________________________

Earnings per Share                        3.50      

Price Earnings Ratio                      7.71

(a) How many common shares must be issued to finance the offering?

(b) How many rights are needed to subscribe to one new share?

(c) What is the ex-rights market value of the common shares?

Solutions

Expert Solution

Money to be raised = $58,750,000

Earnings after tax = 61,250,000

Earnings per Share = 3.5

Earnings per Share = Earnings after-tax/Number of outstanding shares

Current Number of outstanding shares =  Earnings after-tax/Earnings per Share

= 61,250,000/3.5 = 17,500,000

Price Earnings Ratio = Price per share/Earnings per Share = 7.71

Price per share = Earnings per Share*Price Earnings Ratio = 3.5*7.71 = $26.985

The bank will allow shareholders to subscribe to new shares at a price which is $12.97 below the current market price of the common shares.

Hence, the offered price of new stocks = $26.985 - $12.97 = $14.015

Solution a) Number of new shares to be issued = Amount to be raised/Offered price per share

= $58,750,000/$14.015 = 4191937.21

= 4,191,937 (approx)

Solution b) The number of rights to be issued to purchase one new share is known as rights exchange ratio. It is calculated as the ratio of the number of old shares outstanding divided by the number of new shares to be issued.

Number of old outstanding shares = 17,500,000

Number of new shares to be issued = 4,191,937

Number of rights to be issued = 17,500,000/4,191,937 = 4.17

Solution c) Market value of the shares after the rights issue = New total Market Value/New total number of shares outstanding

Old total market value of equity = Old number of shares * Old price per share = 17,500,000*26.985 = $472,237,500

New equity raised = $58,750,000

Total market value = $472,237,500 + $58,750,000

= $530,987,500

New total number of shares = 17,500,000 + 4,191,937 = 21,691,937

The new price per share after the rights issue = 472,237,500/21,691,937 = 24.478565 = $24.48


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