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hey sir..if a company issue rights,what is the effect on its book value and market value equity??assume co X has 10 shares,one share at a Market price of $2.while the par value is $1.it issues 1 for 5 rights at a price of $1.50.what is the equity of co X now in terms of book value and market value after rights issue?
book value;12 X $1= $12
market value:12 X $1.08 (theoritical ex price) =$12.96
these are my answers,correct me if im wrong.if my answers are correct,then i dun see why im wrong when doing december 2004 ques on Tirwen co.ques (e) which requires me to calculate the new debt/equity ratio.i just dun understand why is the equity value after rights issue is 6000.Your book value is correct – $12.
However the ex-rights price is wrong. Currently there are 10 shares with a total market value of $20. There a 2 new shares issued for a total of $3.00. And so the new market value per share will be ($20 + $3)/(10 + 2) = $1.92 per share.
With regard to Tirwen, the reason that the equity increases to 6000 is as follow:
The company is issuing 800 new shares (2000/0.50 x 1/5) at a price of $3.40 per share ($4 – 15%), and so they are raising a total of $2,720, out of which $220 will be paid in issue costs, leaving $2,500 which will increase the total equity on the balance sheet (it is currently 3500, and so it will increase to 6,000).Although only the nominal value of the shares issued will go to the share capital account, the extra raised will increase reserves (the extra issue price over nominal will go to share premium, but then the issue costs will reduce reserves).
Hope that makes sense 🙂
i get it now!!!thank you soooooo much sir!! thank you for giving me your time n going through the whole tirwen question with me!!thats very considerate and kind of you!!again..thank you sooo soo sooo much!!!
I also have a question pertaining to this question – Tirwen Co – December 2004 from the bpp kit.
For part (C) when calculating the revised EPS if funds received from the rights issue is used to redeem the 12% loan notes, the savings to the company was calculated as 12% by funds raised – $300,000. If anyone knows this question, I am not sure why the savings is equal to 12% of the funds raised. I know this might be a given, but I just don’t understand the logic in my head. Can someone help?
Thanks!
They are currently paying 12% interest on the loan notes, and so given that they are repaying loan notes they will save the 12% interest each year.
Hi John,
Another question on this topic. In part C when calculating the revised EPS, why are we adding the interest costs to the EBT? Also I thought the question was asking for the current EPS but the answer only shows the earnings calculations?The current EPS is shown in the first line of the answer to part (c).
For the revised EPS, since the rights issue is being used to repay the loan notes, the interest payable will change – so they have added back the existing interest, and instead subtracted the new interest payments.
The theoretical ex-rights price ignores what is being done with the money raised.
The question says to assume that the PE ratio remains constant and therefore the actual share price ends up being $4 per share. Since this is higher than the TERP, redeeming the debentures is increasing the wealth of the shareholders.
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