A Ltd. has a share capital of 5,000 equity shares of Rs. 100 each having a market value of Rs. 150 per share. The company wants to raise additional funds of Rs. 1,20,000 and offers to the existing shareholders the right to apply for a new share at Rs. 120 for every five share held. What would be the value of right?
Rs. 5
Understanding the Rights Issue
A rights issue is an invitation to existing shareholders to purchase additional new shares in the company. This is a common way for companies to raise additional capital. The shareholders are given a 'right' to buy these new shares, usually at a discount to the market price.
The question asks us to calculate the value of this 'right' for A Ltd. based on the provided information.
Calculating the Number of New Shares Issued
A Ltd. wants to raise Rs. 1,20,000 by issuing new shares at a price of Rs. 120 per share. The number of new shares that need to be issued can be calculated as follows:
\(\text{Number of New Shares} = \frac{\text{Funds to be Raised}}{\text{Offer Price per New Share}}\)
Given:
- Funds to be Raised = Rs. 1,20,000
- Offer Price per New Share = Rs. 120
Calculation:
\(\text{Number of New Shares} = \frac{1,20,000}{120} = 1,000 \text{ shares}\)
So, A Ltd. will issue 1,000 new equity shares.
Determining the Rights Ratio
The company has 5,000 existing equity shares and plans to issue 1,000 new shares. The rights issue offers the right to apply for a new share for every five shares held. Let's verify this ratio with our calculated new shares.
\(\text{Rights Ratio (Existing per New)} = \frac{\text{Total Existing Shares}}{\text{Total New Shares Issued}}\)
Given:
- Total Existing Shares = 5,000
- Total New Shares Issued = 1,000
Calculation:
\(\text{Rights Ratio} = \frac{5,000}{1,000} = 5\)
This confirms that an existing shareholder gets the right to subscribe to 1 new share for every 5 shares they currently hold.
Calculating the Theoretical Ex-Rights Price (TERP)
The theoretical ex-rights price is the expected market price of the share after the rights issue has been completed. It represents the weighted average price of the existing shares (at market price) and the new shares (at offer price).
\(\text{Total Value Before Right} = (\text{Existing Shares} \times \text{Market Price}) + (\text{New Shares} \times \text{Offer Price})\)
\(\text{Total Shares After Right} = \text{Existing Shares} + \text{New Shares}\)
\(\text{Ex-Rights Price} = \frac{\text{Total Value Before Right}}{\text{Total Shares After Right}}\)
Given:
- Existing Shares = 5,000
- Market Price = Rs. 150
- New Shares = 1,000
- Offer Price = Rs. 120
Calculation:
\(\text{Total Value Before Right} = (5,000 \times 150) + (1,000 \times 120)\)
\(\text{Total Value Before Right} = 7,50,000 + 1,20,000 = \text{Rs. } 8,70,000\)
\(\text{Total Shares After Right} = 5,000 + 1,000 = 6,000 \text{ shares}\)
\(\text{Ex-Rights Price} = \frac{8,70,000}{6,000} = \text{Rs. } 145\)
The theoretical ex-rights price is Rs. 145 per share.
Determining the Value of the Right
The value of the right is the difference between the current market price (cum-rights price) and the theoretical ex-rights price.
\(\text{Value of Right} = \text{Market Price per Share} - \text{Ex-Rights Price}\)
Given:
- Market Price per Share = Rs. 150
- Ex-Rights Price = Rs. 145
Calculation:
\(\text{Value of Right} = 150 - 145 = \text{Rs. } 5\)
Alternatively, the value of the right can also be calculated using the formula:
\(\text{Value of Right} = \frac{\text{Market Price per Share} - \text{Offer Price per New Share}}{\text{Number of Existing Shares to get 1 New Share} + 1}\)
Given:
- Market Price per Share = Rs. 150
- Offer Price per New Share = Rs. 120
- Number of Existing Shares to get 1 New Share = 5
Calculation:
\(\text{Value of Right} = \frac{150 - 120}{5 + 1} = \frac{30}{6} = \text{Rs. } 5\)
Both methods yield the same result. The value of the right is Rs. 5.
| Item | Value |
|---|---|
| Existing Shares | 5,000 |
| Market Price per Share | Rs. 150 |
| Funds to Raise | Rs. 1,20,000 |
| Offer Price per New Share | Rs. 120 |
| Calculated New Shares Issued | 1,000 |
| Rights Ratio (Existing:New) | 5:1 |
| Theoretical Ex-Rights Price (TERP) | Rs. 145 |
| Value of Right | Rs. 5 |
Revision Table: Rights Issue Concepts
| Term | Explanation |
|---|---|
| Rights Issue | Offer to existing shareholders to buy new shares, usually at a discount. |
| Cum-Rights Price | Market price of the share before the rights issue record date. |
| Ex-Rights Price (TERP) | Theoretical market price of the share after the rights issue. |
| Value of Right | The theoretical value of the entitlement to buy a new share, calculated as Cum-Rights Price minus Ex-Rights Price. |
| Renounceable Rights | Rights that can be sold by the existing shareholder to another person. |
| Non-Renounceable Rights | Rights that cannot be sold and must be exercised by the existing shareholder or allowed to lapse. |
Additional Information: Importance of Rights Issue
Companies undertake rights issues for various reasons, primarily to raise capital without taking on debt. This capital can be used for expansion, debt repayment, or funding new projects. For shareholders, a rights issue offers an opportunity to maintain their proportionate ownership in the company and potentially buy shares at a price lower than the current market price. However, if they do not exercise their rights (and if the rights are renounceable, they don't sell them), their percentage ownership in the company will be diluted.
The theoretical value of the right calculated here is an estimate. The actual market price of the share ex-rights may differ due to market demand and supply factors.
The calculation of the value of right and the ex-rights price helps shareholders make informed decisions about whether to exercise their rights, sell them (if renounceable), or let them lapse.
Important Questions from Shares
Which of the following distinction(s) is/are not correct between public issue and rights issue?
(A) In public issue, applications for shares are invited from the general public and in rights issue, the shares are offered to existing shareholders.
(B) In public issue there is no question of any over-subscription and in rights issue the shares may be under subscribed or over subscribed leading to prorata allotment.
(C) The price of public issue is generally less than the market price and in rights issue, the price is deliberately made less than the market price.
(D) In a public issue, the communication of the issue is through prospectus or advertisements and in a rights issue the communication is between the company and the existing members of the company.
Choose the most appropriate answer from the options given below:
Match List I with List II:
List I List II (A) Bonus shares (I) Invitation to existing shareholders to purchase additional new shares (B) Demat shares (II) Issue is made to existing members free of charge (C) Right issue (III) Share issues by a company to its employees/directors at a discount for providing know-how (D) Sweat equity share (IV) Shares in electronic form Choose the correct answer from the options given below:
Identify the correct sequence of activities involved in the process of buy back of shares.
A. Letter of offer to the shareholders.
B. Opening of bank account.
C. Approval for Extra-ordinary General Meeting.
D. Convening board meeting.
E. Declaration of Solvency.
Choose the correct answer from the options given below:
Identify the correct statements in context of equity financing.
A. Borrowing limit increases as a consequence of increase in number of shares.
B. Ordinary shares are generally not redeemable.
C. Issue of new shares dilutes the EPS if the profits do not increase immediately in proportion to increase in number of shares.
D. A company is not legally oblidged to pay dividend.
E. Ordinary shares are less riskier from investor's perspective.
Choose the correct answer from the options given below:
Which of the following order is followed in the issue of shares under the "Fixed Price Offer Method"?
A. Issue of a prospectus
B. Receipt by the company of application for share
C. Selection of merchant banker
D. Issue of share certificates
E. Allotment of shares to the applicant
Choose the correct answer from the options given below
