Question

QUESTION 23

1. Brother Ltd is proposing a 1 for 5 pro-rata renounceable rights issue. Presently there are 250,000 shares outstanding at $45 each. In accordance with the rights issue there will be 50,000 new shares offered at $40 each.

   (a) How many shares must an existing shareholder own to obtain a right to a new share?

   (b) What is the theoretical ex-rights share price of Brother Ltd?

   (c) What is the value of a right in Brother Ltd?

   (d) If the shareholder does not want to take up the rights issue based on the type of rights issue what do you suggest the shareholder does? Justify your answer.

Answer 1

a. No of shares existing shareholder must own to obtain right to a new share = 5 shares [ 5 to 1 issue means that for every 5 shares held 1 share is issued]

b. Theoretical ex rights price = 1/ (N+1) *(N*C um rights price) + Issue price) = 1/ (5+1) *(( 5* 45 )+ 40) = 44.167

c. Value of right = Theoretical ex rights price - Issue price = 44.167 - 40 = 4.167

The value of the rights attached to each existing share is $4.167.

d. If the shareholder does not want to take up the rights issue he can sell the right share for $4.167. The effect of this will remain neutral on his portfolio. Effect:

Sale value of rights (1* 4.167 ) = 4.167

Market value of shares (5* 44.167) = 220.833

Total value = 225

Total value of the shares c um rights = 5* 50 = 225

The shareholder has no gain or loss in wealth