Q. Evaluate Value of rights per existing share?

Rights issue price = 4·00 × 0·85 = $3·40

Theoretical ex rights price = ((5 × 4·00) + 3·40)/6 = $3·90

Value of rights per existing share = (3·90 - 3·40)/5 = 10c

(b)

Value of 1200 shares after rights issue = 1200 × 3·90 =$4680

Value of 1000 shares before rights issue = 1000 × 4·00 =$4000

Value of 1000 shares after rights issue = 1000 × 3·90 = $3900

Cash subscribed for new shares = 200 × 3·40 = $680

Cash raised from sale of rights = 1000 × 0·1 = $100

The investor could do nothing occupy the offered rights and sell the rights into the rights market or any combination of these actions. The consequence of the rights issue on the wealth of the investor depends on which action is taken.

The rights issue has a impartial effect if the rights attached to the 1000 shares are exercised to purchase an additional 200 shares since the value of 1200 shares after the rights issue ($4680) is equal to the sum of the value of 1000 shares before the rights issue ($4000) and the cash subscribed for new shares ($680). Part of the investor's wealth has altered from cash into shares but no wealth has been gained or lost. The theoretical ex rights per share consequently acts as a benchmark following the rights issue against which other ex rights share prices can be compared.

The rights issue as well has a neutral effect on the wealth of the investor if the rights attached to existing shares are sold. The value of 1000 shares subsequent to the rights issue ($3900) plus the cash received from the sale of rights ($100) is equal to the value of 1000 shares before the rights issue ($4000). In this case part of the investor's capital has changed from shares into cash. If the investor neither subscribes meant for the fresh shares offered nor sells the rights attached to the shares already held a loss of wealth of $100 will take place due to the difference between the value of 1000 shares before the rights issue ($4000) and the value of 1000 shares after the rights issue ($3900).

The theoretical ex rights price is merely a weighted average of the come rights price and the rights issue price ignoring any use made of the funds raised. The real ex rights price will depend on the utilize made of the funds raised by the rights issue as well as the expectations of investors and the stock market.