Question

Supernova makes a public announcement that it will raise equity finance through a rights issue of new shares to existing shareholders to finance a new project. The new project and the rights issue are announced simultaneously. The project has an NPV of $10 million and requires an initial outlay of $20 million. The rights issue shares will be priced at $2 each. Assume that before making public the information about the new project or its financing, the firm had 20 million shares with a market value of $3 per share. The market is semi-strong form efficient and there are no issuance costs. What is the value of a share in Supernova after the rights issue? What is the value of a right to obtain one of the rights issue shares? Why should an outside investor be unwilling to pay more?

Answer 1

No of shares issued as right shares = 20/2= 10million

value of the sahre after the right = Total value of shares after the right / total no of shares after the right

= (10*2 + 20*3 ) /( 20 +10) = 2.67

no of shares required for 1 right share = no of shares as right / total no of shares before right = 10 / 20 = 1/2

ie 1 right issue is issued to shareholder having 2 shares

Value of the right = ( share price before right issue - subscription price ) / ( no of share required for 1 right issue + 1)

= ( 3 -2.67) / ( 2 +1)

= 0.11