Question

May plc has 10 million ordinary shares in issue, and its current market price is £8.00 per share. The company wishes to embark on a major expansion programme and, given its current high level of financial gearing, has decided to raise new equity of £4 million.

The company is seeking your advice on a number of potential share issue methods:
(i) An rights issue at a 25% discount to the current market price;
(ii) A deep discounted rights issue at a 50% discount;
(iii) A placing of shares with institutions at a 12 1/2% discount to the current market price.
Required:
a) Calculate the theoretical ex-rights price under options (i) and (ii).

Answer 1

The theoretical ex-rights price for a 25% discount rights issue of May plc is £7.25 per share, while for a 50% discount rights issue, it is approximately £7.27 per share.

Step-by-step explanation:

The theoretical ex-rights price (TERP) is the average price per share post the new issue, considering the new shares are issued at a discount. When May plc issues new shares at a discount to the current market price, the TERP can be calculated for both a 25% discount and a 50% discount.

Using the formula TERP = [(Old shares x Market price) + (New shares x Issue price)] / (Old shares + New shares), let's calculate:

1. 25% Discount Rights Issue: At a 25% discount, the issue price is £8.00 - 25%, which equals £6.00 per share. If the company wants to raise £4 million, they need to issue £4 million / £6.00 per share = 666,667 new shares. Plugging these into the TERP formula: [(10,000,000 shares x £8.00) + (666,667 shares x £6.00)] / (10,000,000 + 666,667) = £77,333,336 / 10,666,667 shares = £7.25 per share.
2. 50% Discount Rights Issue: At a 50% discount, the issue price is £8.00 - 50%, which is £4.00 per share. For raising £4 million, the company will issue £4 million / £4.00 per share = 1,000,000 new shares. The TERP would be: [(10,000,000 shares x £8.00) + (1,000,000 shares x £4.00)] / (10,000,000 + 1,000,000) = £80,000,000 / 11,000,000 shares = about £7.27 per share.

In the context of this question, the discounts being offered affect the amount of money raised and the number of new shares issued, which in turn affects the TERP.