Rights issue.

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Issue of shares for cash

A rights issue is an issue of shares for cash.

These shares are usually issued at a discount to the current market price.

The 'rights' are offered to existing shareholders, who can sell them if they wish.

Advantages
  • Raises cash

  • Reserves are available for future dividend distribution

Disadvantages
  • If a shareholder sells his rights, he will be losing (diluting) his control in the company

Illustration 1 - TERP

Cow Co. makes a 1 for 5 rights issue, at $2.50 (MV before issue made $3)

This market value just before the issue is known as the cum rights price.

What is the theoretical ex-rights price?

Solution

5 shares @ $3.00
1 share @ $2.50

# of shares $
5 shares  @$3.00 15.00
1 share  @ $2.50 2.50
6 shares 17.50

So the value per share after the rights issue (TERP) is: $17.50/6 = $2.92

NotesQuizCBE