Question

Brand plc generates profit after taxation of 15% on shareholders’ funds. Its current capital structure is as follows: $ Ordinary shares of 50p each 200,000 Shares premium 87,500 Reserves 312, 500 The board of Brand plc wishes to raise $160,000 from a rights issue in order to expand existing operations. Its return on shareholders’ funds will be unchanged. The current ex-div market price of Brand plc is $1.90. Three different rights issue prices have been suggested by the finance director: $1.80, $1.60 and $1.40. Determine the number of shares to be issued, the theoretical ex-rights price, the expected earnings per share and the form of the issue for each rights issue price. Comment on your results.

Answer 1

To determine the number of shares to be issued, theoretical ex-rights price, expected earnings per share, and form of the issue for each rights issue price, calculations need to be done. For a rights issue price of $1.80, 88,889 shares would be issued, theoretical ex-rights price would be $1.8346, expected earnings per share would be $0.2464, and form of the issue would be 1 new share for every 4 existing shares. For a rights issue price of $1.60, 100,000 shares would be issued, theoretical ex-rights price would be $1.8684, expected earnings per share would be $0.2353, and form of the issue would be 1 new share for every 3 existing shares. Finally, for a rights issue price of $1.40, 114,286 shares would be issued, theoretical ex-rights price would be $1.9045, expected earnings per share would be $0.2271, and form of the issue would be 1 new share for every 2 existing shares.

Step-by-step explanation:

To determine the number of shares to be issued, we need to divide the amount to be raised ($160,000) by the rights issue price. For each suggested rights issue price, the number of shares to be issued would be:

Rights issue price $1.80: 160,000/1.80 = 88,888.89 shares (rounded to 88,889 shares)

• Rights issue price $1.60: 160,000/1.60 = 100,000 shares
• Rights issue price $1.40: 160,000/1.40 = 114,285.71 shares (rounded to 114,286 shares)

The theoretical ex-rights price can be calculated by dividing the total value of the company before the rights issue ($1.90 * 200,000 shares) plus the amount to be raised ($160,000) by the total number of shares after the rights issue. The ex-rights price would be:

Rights issue price $1.80: (1.90 * 200,000 + 160,000) / (200,000 + 88,889) ≈ $1.8346

• Rights issue price $1.60: (1.90 * 200,000 + 160,000) / (200,000 + 100,000) ≈ $1.8684
• Rights issue price $1.40: (1.90 * 200,000 + 160,000) / (200,000 + 114,286) ≈ $1.9045

The expected earnings per share can be calculated by multiplying the existing profit after taxation (15% of shareholders' funds) by the number of shares after the rights issue:

Rights issue price $1.80: (0.15 * (200,000 * 1.80 + 160,000)) / (200,000 + 88,889) ≈ $0.2464

• Rights issue price $1.60: (0.15 * (200,000 * 1.60 + 160,000)) / (200,000 + 100,000) ≈ $0.2353
• Rights issue price $1.40: (0.15 * (200,000 * 1.40 + 160,000)) / (200,000 + 114,286) ≈ $0.2271

The form of the issue for each rights issue price would be:

Rights issue price $1.80: 1 new share for every 4 existing shares

• Rights issue price $1.60: 1 new share for every 3 existing shares
• Rights issue price $1.40: 1 new share for every 2 existing shares

In summary, for a rights issue price of $1.80, 88,889 shares would be issued, the theoretical ex-rights price would be approximately $1.8346, the expected earnings per share would be around $0.2464, and the form of the issue would be 1 new share for every 4 existing shares. For a rights issue price of $1.60, 100,000 shares would be issued, the theoretical ex-rights price would be about $1.8684, the expected earnings per share would be approximately $0.2353, and the form of the issue would be 1 new share for every 3 existing shares. Finally, for a rights issue price of $1.40, 114,286 shares would be issued, the theoretical ex-rights price would be approximately $1.9045, the expected earnings per share would be around $0.2271, and the form of the issue would be 1 new share for every 2 existing shares.