Santa PLC is an all equity financed company with 100 million shares outstanding trading at 2...

 

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Santa PLC is an all equity financed company with 100 million shares outstanding trading at €2 per share. Its management has decided to invest in a major new development that will cost € 40 million, and is now considering ways to finance the investment. Various alternatives have been considered but the choice has been narrowed down to a rights issue or the issue of debentures (a kind of bond). The rights issue would be made at a discount of 20% and be underwritten at a cost of 2% of the proceeds. The company's chairman has discussed the proposed investment and its prospects as well as the financing possibilities, quite openly with various institutions and the financial press. As a result it is likely that the share price already reflects the implications of the company's proposed investment. Required : a) Determine the terms of the right issue, the ex-rights price and the theoretical value of the right. (5 marks) b) Demonstrate that in principle the shareholders will be equally well off by subscribing to the issue or by selling their rights. Assume the shareholder has 100 shares. (3 marks) c) Explain the impact on the value of the right if the issue is undertaken on the specified terms and the share (cum-rights) price falls to € 1.8 shortly after the shareholders are invited to subscribe to the new issue. (2 marks) Santa PLC is an all equity financed company with 100 million shares outstanding trading at €2 per share. Its management has decided to invest in a major new development that will cost € 40 million, and is now considering ways to finance the investment. Various alternatives have been considered but the choice has been narrowed down to a rights issue or the issue of debentures (a kind of bond). The rights issue would be made at a discount of 20% and be underwritten at a cost of 2% of the proceeds. The company's chairman has discussed the proposed investment and its prospects as well as the financing possibilities, quite openly with various institutions and the financial press. As a result it is likely that the share price already reflects the implications of the company's proposed investment. Required : a) Determine the terms of the right issue, the ex-rights price and the theoretical value of the right. (5 marks) b) Demonstrate that in principle the shareholders will be equally well off by subscribing to the issue or by selling their rights. Assume the shareholder has 100 shares. (3 marks) c) Explain the impact on the value of the right if the issue is undertaken on the specified terms and the share (cum-rights) price falls to € 1.8 shortly after the shareholders are invited to subscribe to the new issue. (2 marks)

Answer rating: 100% (QA)

a A theoretical ex rights price is the market price that a stock will theoretically have following a new rights issue companies may use a new rights issuance to offer moreshares to shareholders usuall... View the full answer