Rights Issue – Example

ADVERTISEMENTS

Assume company XYZ has announced rights issue in the ratio of 5:2 (for every 5 shares additional 2 shares are offered). If you hold 100 shares of XYZ then you will be entitled to get 40 (100 * 2/5) new shares of XYZ. The new shares are usually given at deep discount price so that the full issue gets subscribed and the company may raise the required capital. A future date is fixed for this corporate action. 

After this corporate action the share price comes down proportionate to the issue ratio, theoretically.  Actual value differs from this theoretical value based on the intention of the funds’ raise.

Consider share price of XYZ is Rs 300 and the company is offering new shares at Rs 200 and you hold 100 shares of XYZ.

You can buy 40 shares at Rs 200. The amount required to buy new shares Rs 8000.
Value of the existing shares 300 * 100 = Rs 30,000
Total value of 140 shares = 30,000 + 8000  = Rs 38,000
Theoretical share price ex-rights = 38,000 / 140 = Rs 271.5

In case of rights issue you have the below options to choose.

1.    No action at all. It’s not recommended since it dilutes the value of your existing shares. i.e. in the above example you would left with 100 * 271.5 = Rs 27,150 (whereas the original value was Rs 30,000).
2.    Opt to buy all the shares you are entitled to by paying Rs 8000. As explained above. You will have 140 shares with a theoretical price of 271.5
You can buy a part of the shares you are entitled to.
3.    Opt to sell the shares to other investors or the underwriter in which case theatrically you would get Rs 271.5 * 40 and you need to pay Rs 8000 (40 * 200) . Capital gain is the difference which is Rs 2860. Of course there will be capital loss on your existing 100 shares to compensate this.

The actual ex-rights price depends on the intention of funds’ raise and market sentiment. So you may end up in losses or profit  depending on the option you choose.

ADVERTISEMENTS

{ 4 comments… read them below or add one }

Clive o'sullivan May 23, 2010 at 1:50 am

In the case of a rights issue of lets say 3 for every two I already own, will my rights entitle me to maintain/keep the percentage of the company I already own. If I don’t have any cash to take up the purchace of any extra shares I would imagine it is logical that my rights should at least allow me to keep the percentage ownership in the company that I already own. I shouldn’t have to provide any extra cash for a percentage when the percentage was already mine to begin with.

Reply

sabari raj r July 8, 2011 at 2:59 pm

Rights issue is very good for the partners of the company & the company also.So it is very good.

thank you
sabari raj r

Reply

paul Awofadeju August 4, 2011 at 2:33 pm

about issue of share and how we take issue share such like .bonus, right and convertible issue

Reply

Sathish Emmadi August 5, 2011 at 2:49 pm

Hi Paul,

Your question is not clear. If you were referring to “How the Bonus issue” works, Please read the below link.

http://lastbull.com/bonus-issue-truths-revealed/

Reply

Leave a Comment

*