May PLC has 10 million ordinary shares in issue and its current market price is £8.00 per share.
The company wishes to embark on a major expansion programme and, given its current high level of financial gearing, has decided to raise new equity of £4 million.
The company is seeking your advice on a number of potential share issue methods:
(i) A rights issue at 25% discount to the current market price;
(ii) A deep discounted rights issue at 50% discount;
(iii) A placing of shares with institutions at 12 ½% discount to the current market price.
a) Calculate the theoretical ex rights price under options (i) and (ii)
b) An investor, Mr. Khan that owns 1000 shares is concerned that he will not be able to buy shares in the rights issue given that he feels that he holds enough investment in May plc shares and would like to diversify to another investment. Demonstrate to Mr. Khan whether he will lose value if he does not buy shares in the rights issue and advise him on the best possible outcome. Consider a scenario where the company chooses the cheaper rights issue option of a deep discount.
c) Calculate the effect on Mr. Khan’s wealth if the company chooses to raise money through a placing of shares under option (iii).
d) Comment on why UK insurance companies and pension funds may prefer companies, in which they invest, to have rights issues rather than placings to raise new equity capital.
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