5,000,000 Ordinary shares of £1 each fully paid

(currently quoted on the Stock Exchange at 220p each)

The directors wish to raise funds to the extent of £1,500,000 in order to modernise the plant. They therefore send a provisional allotment letter to their shareholder offering one new ordinary share at 150p for every five shares held.

From the company's point of view, because the shares are offered at a favourable price, the company can be sure of receiving the funds they require. If they have been too generous with the terms, it is only the existing equity owners who will benefit. It is an inexpensive and effective method of raising additional funds which is likely to prove acceptable to the shareholders, so long as proportionately large sums are not required.

From the shareholder's point of view consider the case of Mark Johnson, who was holding 1,000 ordinary shares in Delta. He would have been invited to take up 200 of the new ordinary shares at a price of 200 x 150p, i.e. £300.00. If he wishes to acquire all the new shares to which he is entitled, all he needs to do is to send a cheque for this sum to the company registrar, together with the allotment letter.

If he does not want to take any of the new shares he may sign the form of renunciation and give the allotment letter to his broker who will then sell the rights on his behalf.

How much can Mark expect to receive from any rights he sells? The stock market has assessed Delta as being worth £11m, i.e. 5,000,000 x £2.20. With the new inflow of cash from the rights issue, the amended valuation of Delta would be £12.5m. Divided between 5,000,000 old and 1,000,000 new shares (6,000,000 in total) the value of the shares – after the rights issue – would be

£12,500,000 / 6,000,000 = approximately £2.08

So, if shares costing £1.50 each are worth £2.08, the value of the rights to each new share (called the premium) will be around 58p. In practice, the premium may exceed 58p where the injection of cash is expected to improve the efficiency of the company. You will recall that Delta wanted the cash to modernise their plant.

If Mark sells all his rights, he will receive a cheque from the broker (having sold the rights on the stock exchange) for 200 x 58p = £116.00.

Your task

Beta plc has the following capital structure: 10,000,000 ordinary shares of £1 each.

The shares are selling on the Stock Exchange £4.00 each.

The company is now making a one for ten rights issue at a price of £3.00 each.

1. How many new shares would you expect to be offered if you are presently holding 5,000 of the Beta ordinary shares?

2. How much would you have to pay the company for your new shares?

3. How much would Beta raise from the rights issue?

4. How would you be informed about the rights issue?

5. What is attractive in such a rights issue from the company's point of view?

6. What are the merits and demerits of the rights issue from the shareholder's point of view?

7. With regard to the Beta rights issue, what would you expect the premium to be on the rights?

8. How much would you get for your rights to new shares if you sold them instead of taking them up?

Section H. True or false

If you think the statements are true, put the letter “T”. If you think they are not true, put the letter “F”.

1. The Stock Exchange does not provide companies with funds; it is a market place for the purchase and sale of stocks and shares.

2. The purpose of a take-over bid may be to eliminate competition.

3. The directors may recommend that part of the profits are ploughed back* into the business.

4. Non-voting shares will be of no interest to a take-over bidder.

5. Ordinary shares carry one vote each at the company's general meetings.

6. If shares are quoted on the Stock Exchange they will fetch a lower price.

7. When a company is taken over, the existing board of directors will be unaffected.

8. If you won 1,000 ordinary stock units of £1 each in ICI and a dividend of l0p per unit is declared, you will receive £100, less tax.

9. If directors pay low dividends to the shareholders over a period of time, take-over bidders will be discouraged.

10. An inexpensive way for a company to raise funds is by a rights issue to its own shareholders.

Delta plc