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February 1, 2020 at 4:33 pm
Hi A quick quite question if you don’t mind. Why is so important that the net cash position won’t change when they purchase a new right share. I would think they are buying the share to get wealthier, hence their cash effect is zero, what short term benefits they have?
or we assuming a long term benefit once company grows?
many thanks in advance Anna
John Moffat says
February 1, 2020 at 5:20 pm
Either I am misunderstanding what you have written, or you have misunderstood the lecture a bit 🙂
There is certainly no requirement that the net cash position should not change. Investors decide whether or not to buy shares (whether or not it is a rights issue) based on what they expect will happen to the shares in the future. However buying shares obviously involves paying out cash and it is quite common in the case of a rights issue that some shareholders do not want to pay out more cash but would rather receive some of the extra shares rather than sell all of the rights and receive cash. Because many shareholders do have this attitude, it is something that could be asked in the exam (and is asked in the specific example I work through) – how many of the rights should they take up and how many should they sell if they do want to have no change in their cash balance. However individual shareholders do not have to do this and we only do it in the exam if it is specifically asked for.
February 1, 2020 at 10:06 pm
thank you for coming back to me. Perhaps I should illustrate my question with an example to avoid misinterpretation.
Taking the example 2 point C and D. I understand the calculation, however, I am confused with the purpose of the whole exercise. What is the point of taking up or selling the rights, if the shareholder is not better or worse off, as the net cash effect is zero? Is that because the shareholder thinking long term and not cash flow? Forgive me if I am being silly, but I just want to make sure I got this right. many thanks again Anna
February 2, 2020 at 10:45 am
The net cash effect is only zero in the case of part D of the example.
Every shareholder has the choice of either paying out cash and getting more shares, of receiving cash but getting no extra shares, or any combination in-between. In theory their overall wealth (cash plus shares) will stay the same initially, but what they decide to do will depend on various factors such as do they have the cash available to buy more shares? What do they think will happen to the share price in the future? They are thinking long-term – for example they might choose to sell all their rights because they could use the cash they receive to buy shares in another company that maybe they think is a better investment for the future.
The reason that any investor ever buys shares in any company is because they are hoping for future income or capital growth.
Rights issues give flexibility to the shareholders – they have the chance of owning more shares in the company but they are not forced to buy more shares.
February 2, 2020 at 12:58 pm
thank you John, for clarifying this. I do have a better understanding now.
many thanks again Anna
August 20, 2019 at 5:53 pm
Hi Mr John, Thank u for your valuable and interesting lectures,
regarding example 2 part c & d
You said that in theoretical, there will be no change in the net wealth after buying the right share.
in that applicable for all cases and what the logic behind that, I understand it in term of the numbers but I would really appreciate if you could explain the logic behind it to be more sense to me
August 20, 2019 at 6:07 pm
If the owners (i.e. the shareholders) pay an extra $1,000 into the company then they will be owed $1,000 more by the company than they were owed before – that is basic accounting.
However, as I explain in the lecture that only gives us the theoretical ex-rights price because it ignores what the company intends doing with the money raised.
April 24, 2019 at 3:37 am
Hello Mr John! Are there any lectures on dividend policy ?
April 24, 2019 at 6:50 am
Yes – the next lecture on Chapter 11 of the free lecture notes together with the notes themselves.
March 23, 2019 at 3:19 pm
I worked out part (d) differently by pausing the lecture to see if I get the same result, and I used a different methodology but obtained the same answer. Just wanted to check whether one could use the following working:
$1.50 is the difference between the TERP and the rights price ($7.50-$6) $7.50 is the TERP
The proportion of 1.50/7.50 is 20%, so 20% of the offered rights would be 80 shares.
March 23, 2019 at 4:12 pm
That’s fine 🙂
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