Question

ABC Inc currently has 500,000 shares outstanding at $44 each. The company is proposing a rights offering with subscription price set at $35. Shareholders will need to have four rights to exercise their right to buy each new share.

I. What is the new market value of the company after the rights issue?

II. What is the value of each right? What is the ex-rights price of shares?

III. ABC managers want the ex-rights price to be $42.80. What should the subscription price be to ensure the desired ex-rights price?   

IV. Why is ABC Inc having a rights offer than a general cash offer to raise new funds?

Answer 1

ANSWER DOWN BELOW. FEEL FREE TO ASK ANY DOUBTS. THUMBS UP PLEASE.

1. Market value of company after rights issue = (old number of shares* old market price) + (number of right shares issued* subscription price)

= 500,000*44 + (500,000*1/4 * 35)

= 26,375,0000

2. Ex right price per share = new market value/ total no.of shares.

= 26,375,0000/ 625,000

= 42.2

Value of right = Old price- Ex price = 44-42.2 = 1.8

3. For ex right price to 42.8 the desired subscription price =

Let the new subscription price be X.

(22,000,000+X*125,000)/ 625,000 = 42.8

X = 38 (Answer).

4. Right issues increase the wealth of the existing shareholders. It helps achieve the wealth maximization objective of the firm. It also ensures that existing % of shares position is not significantly diluted by entrance of the new shareholders.