What is a Rights Issue?

A rights issue is when a public company issues new shares to raise cash.

There are various reasons why a company might choose to do this: perhaps because it is running short of cash, or may be because it wants to make an expensive investment. By putting more shares on the market, a company dilutes the value of its existing shares.

Example

Mr. Smith had 100 shares of company XYZ at a total investment of £40,000, assuming he purchased the shares at £400 per share.

Assuming a 1:1 rights issue at an offer price of £200, Mr. Smith will have the option to subscribe to additional 100 shares of the company at the offer price. Now, if he exercises his option, he would have to pay an additional £20,000 in order to acquire the shares, thus effectively bringing his average cost of acquisition for the 200 shares to £300 per share ((40,000+20,000)/200=300). Although the price on the stock markets should reflect a new price of £300, the investor is actually not making any profit nor any loss.

Company XYZ has 100 million outstanding shares. The share price currently quoted on the stock exchanges is £400 thus the market capitalization of the stock would be £40 billion (outstanding shares times share price).

If all the shareholders of the company choose to exercise their stock option, the company’s outstanding shares would increase to 200 million. The market capitalization of the stock would increase to £60 billion (previous market capitalization + cash received from owners of rights converting their rights to shares), implying a share price of £300 (£60 billion / 200 million shares).

If the company were to do nothing with the raised money, its Earnings Per Share (EPS) would be reduced by half. However, if the equity raised by the company is reinvested (for example, to acquire another company), the EPS may be impacted depending upon the outcome of the reinvestment.

For more information go to http://en.wikipedia.org/wiki/Rights_issue

Go back to MyBookkeepingManager User Guides home page