Curious about how to determine the impact of an upcoming right issue on your investments? Dive into the essentials of a right issue of shares calculation. How will it affect shareholder equity? Are you prepared to navigate the opportunities and risks?
Right Issue of Shares Calculation: A How-to-Manual
A rights issue of shares allows a company to raise additional capital by offering existing shareholders the chance to buy more shares at a discounted price. Here's how the calculation works:
Determine the Offer Ratio – As an example, a 1-for-4 rights issue allows shareholders to purchase one additional share for every four shares they currently own.
Calculate the Discount Price - The company sets a discounted price per share for the rights issue, usually lower than the current market price.
Calculate Capital Raised - Multiply the discounted price by the number of new shares offered.
Calculate the Theoretical Ex-Rights Price (TERP): TERP is the adjusted price per share after the rights issue. This is calculated by adding the value of existing shares and the new shares raised, then divided by the total number of shares.
Shareholder Participation - Shareholders have the option to subscribe to, sell, or ignore their rights. If they choose to ignore them, their ownership percentage may dilute as additional shares enter the market.
The right issue of shares calculation assists companies raise funds while giving shareholders the option to increase their stake at a discount. Let’s look at a scenario:
Scenario
Rhonda’s Rowboats announces a 1-for-4 rights issue at a discounted price of $15 per share. The current share price is $20, and the shareholder owns 100 shares.
Determine How Many New Shares the Shareholder Can Buy
- The offer ratio is 1-for-4, meaning for every 4 shares owned, the shareholder can buy 1 new share.
- Since the shareholder owns 100 shares, they can buy 100/4 = 25 new shares.
Calculate the Total Cost of Buying New Shares
- The cost per new share is $15.
- For 25 shares, the total cost is 25 × 15 = $375
Calculate the Theoretical Ex-Rights Price (TERP)
- The total value of the original shares at $20 each is 100 shares × $20 per share = $2,000
- The value of the new shares is 25 new shares × $15 rights issue discounted price = $375 total cost of the new shares
- The total combined value is $2,000 value of original shares + $375 value of new shares = $2,375 combined value of original and new shares
- The total number of shares after the rights issue is 100 original shares + 25 new shares = 125 total number of post-right issue shares
- TERP = $2,375 combined value of original and new shares / 125 total post-right issue shares = $19 per share
Post-rights issue, the new theoretical price per share (TERP) is $19, and the shareholder now owns 125 shares (100 original + 25 new). This approach allows shareholders to expand their holdings at a discount and provide the company with additional capital. A rights issue of shares calculation helps shareholders determine the cost and potential benefits of purchasing additional discounted shares.
Right Issue of Shares Calculation: Where to Apply It?
A rights issue of shares calculation is applicable as follows:
Capital Raising: Companies use rights issues to raise additional capital from existing shareholders. This can fund expansion, pay off debt, or improve operations without taking on additional debt.
Shareholder Value: Right issues are applied to ensure fair treatment of existing shareholders by offering them the first opportunity to buy additional shares at a discounted rate, maintaining their ownership percentage.
Market Sentiment: Right issues can be used as an investor gauge of a company's confidence in its future prospects. A right issue can signal growth opportunities or a need for financial restructuring.
Dilution Management: The issue assists shareholders in understanding the potential dilution of their holdings and making informed decisions on participating in the right issue to maintain their ownership stake.
What Are the Disadvantages of Right Issues?
Dilution of Ownership - One of the primary disadvantages of a right issue is the dilution of ownership. When new shares are issued, the total number of shares outstanding increases. If existing shareholders do not participate in the rights issue, their percentage ownership in the company will decrease. This can reduce their influence over company decisions and potential future earnings.
Market Perception - Announcing a right issue can sometimes be perceived negatively by the market. Investors might interpret it as a sign that the company is in financial trouble or unable to secure capital through other means. This perception can lead to a drop in the share price, affecting the company's market valuation.
Cost - Conducting a right issue can be expensive. There are various costs involved, including underwriting fees, legal fees, administrative costs, and marketing expenses to inform shareholders about the rights issue. These costs can add up and reduce the net capital raised.
Short-Term Pressure - A right issue can place short-term pressure on shareholders to invest additional capital quickly. Shareholders need to decide whether to take up the offer, sell their rights, or let the offer lapse, often within a limited time frame. This can be particularly challenging if the right issue is not well-timed or if shareholders are not able to invest more money at that moment.
Understanding the right issue of shares calculation including the advantages and disadvantages is crucial for both the company considering a right issue and the investors who choose to participate. It assists in making informed decisions and managing the potential risks associated with the process.
