Example
ABC Office Solutions has been incorporated as ABC Plc and has been in business for several years. The industry has grown steadily, the company has been using equity and debt finance in business.
One of its existing debts, £ 6 million 7% debenture is approaching maturity. The directors are considering to raise equity finance to repay this debt. The board has been discussing this and has looked at the possibility of a rights issue. In addition, one of the directors has mentioned a capitalisation issue.
Required:
ABC Plc has 18 million fully paid £1 ordinary shares. The current price per share is £1.75. Earnings in the most recent accounts were £0.25 per share. The company wishes to repay £6 million 7% debenture by making a 1 for 3 rights issue of ordinary shares. The rate of corporation tax is 30%.
(i) How many new shares would be issued?
(ii) What would be the issue price per share?
(iii) What would the new earnings per share (EPS) be and the resultant dilution per share?
(iv) What would be the theoretical ex-rights price of the shares and the corresponding price/earnings (P/E) ratio?
(v) What would be the value of the rights on the new shares?
(vi) What would be the value of the rights on the existing shares?
(i) Number of New Shares:
1 for 3 rights issue
Currently 18 million shares.
Number of new shares = 18m ÷ 3 = 6m new shares.
(iii) New Earnings per Share:
£,000 £,000
Current earnings (18m x £0.25 ) 4,500
Interest saved after redemption (£6m x 7%) 420
Less: tax payable on increased profits
(30% of 420,000) (126) 294
Earnings after redemption 4,794
EPS = £4,794,000 ÷ (18,000,000 +6,000,000 ord shares)
= £0.20
Resultant Dilution would be £0.25 - £0.20 = £0.05 per share
(v) Value of rights on new shares
(£1.56 - £1.00) = £0.56 per share
(ii) Issue Price per Share:
Raising £6m through 6m new shares.
Issue Price per share = £6m ÷ 6m = £1.00
(iv) Theoretical ex-rights Price:
Market value cum-rights:
3 shares x £1.75 = 5.25
Rights issue price of 1 share at £1.00 = 1.00
Theoretical ex rights price of 4 shares 6.25
Theoretical ex rights price of shares
= £6.25÷ 4 = £1.56
P / E ratio = £1.56 ÷ £0.20 = 7.8
(vi) Value of rights on existing shares
= (£1.56 - £1.00)÷ 3 = £0.186 per share
or 18.6p per share