Right issue

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RI is the selling of share to existing shareholders in proportion of their current shareholding and often at a discount to the current share price.

Note:

Existing shareholders

Current proportion of shareholding

Discount

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Cheaper than offer for sale to the general public.

No prospectus is required (if right issues is less than 10% of class of share concerned)Administration is simpler and under writing will be

less.

If all the shareholders take their right issues, the relative voting rights are going to be unaffected.

The finance raised can be used to reduce gearing in book value term by increasing share capital and /or to pay off long-term loans.

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The new share price after the issue is known as the theoretical ex-right price and is calculated as follows.

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Theoretical Ex Right price (TERP):

(Market value of old shares before right issue) + (proceeds of right issue)

TERP = Number of share ex-rights.

Upon the issue of the right, an existing shareholder often has four (4) options available to them.

Options are:

Take up the right

Sell the right

Buy part and sell part

Do nothing

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Warmah business school, which has an issue capital of 2,000,000 shares, and a current market value of £2.70 each, makes a right issue of one new share for every two existing shares at a price of £2.10

Required

Calculate the theoretical ex- right price

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2m share x £2.70/share = £5.4m

1 for 2 share = 1m x £2.1/share = £2.1m

3 shares = £7.5m

7.5m/3m = £2.50/share

The theoretical ex-right price = £2.50

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Suzie a shareholder of warmah business school has 1,000 shares before the right offer, how would she be affected under each of the four (4) options available to existing shareholder

(i) Take up the right issue shares

(ii) Sell all the right issue shares

(iii) Buy 200 shares and sells the remaining 300 shares

(iv) Do nothing

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IN OUT If Suzie buy all the shares and keep all the shares 1,000 shares @ £2.70 2,700 1,500 shares @ £2.50 = 3,750 500 shares @ £2.10 1,050 3,750 3,750

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If Suzie buy the shares and sell all the right issue

1,000 shares @2.70 2,700 1,000 shares @ 2.50 = 2,500 500 rights @ 0.4 (2.50 – 2.10) = 200 2,700 = 2,700

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IN OUT If Suzie buy 200 shares and sells the remaining 300 right issue shares 1,000 shares @ £2.70 2,700 1,200 shares @ £2.50 = 3,000 200 shares @ £2.10 420 300 shares @ (2.50 – 2.10) = 120 3,120 3,120

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Suzie could decide to do nothing 1,000 shares @ £2.70 2,700 1,000 shares @ £2.50 = £2,500* * Potentially Suzie could lose out by doing nothing. But in practise the organisation will sell the rights on her behalf and send her a cheque less any administrative cost (if any).

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