Question

Hughes Computer Equipment Limited has 800,000 ordinary shares on issue, and the current market price is $4.20 per share. The company wishes to raise $600,000 in additional equity capital by way of a rights issue.

Provide answers to the following questions:

a. If the company sets a subscription price of $3.75 per share for the rights issue, how many rights will Colin, who currently holds 3,000 shares, receive?

b. What is the theoretical value of a right prior to the ex-rights date, based on the company’s current market share price of $4.20?

c. If the closing share price on the trading day prior to the ex-rights date is still $4.20, at what price should the Hughes Computer Equipment Limited shares open at on the ex-rights date, all other things being equal?

d. Hughes Computer Equipment Limited is considering whether to have its rights issue underwritten or not. The company’s broker has indicated that, if the issue is non-renounceable, the underwriting fee will be larger than if the issue was renounceable. Outline the risks faced by the underwriter in relation to this rights issue, and explain why there may be a difference in underwriting fees.

Answer 1

a. The company wishes to raise $600,000 @ 3.75$ per share = 160,000 right issues has to be issued

as the outstanding number of share is 800,000, thus on a prorata basis for every 10 shares the individual will have a right to subscribe to 2 share i.e. 160,000/800,000 = 2/10 = 2:10 ratio

As colin holds 3000 shares. Thus colin will receive = 3000*(2/10) = 600 shares @3.75

b. value of shares post rights issue =

Current market cap = 4.20*800,000 = 3,360,000

Rights share value = 3.75*160,000 = 600,000

Total value / total share = (3360000+600000)/(800000+160000) = 4.125 post rights share issue

thus rights price = 4.125 - 3.75 = 0.375

c. 4.125