- 15 Marks
FM – L2 – Q29 – Sources of finance: equity
Question
Kumasi Lubricants Plc wishes to increase its production capacity by purchasing additional plant and equipment at a cost of GH¢3.8 million. The abridged statement of profit or loss for the year ended 30th November 20X6 is as follows:
| GH¢m | |
|---|---|
| Sales turnover | 140.6 |
| Profit before interest and taxation | 8.4 |
| Interest | 6.8 |
| Profit before tax | 1.6 |
| Tax | 0.4 |
| Profit after taxation | 1.2 |
Earnings per share: 15 cents
In order to finance the purchase of the new plant and equipment, the directors of the company have decided to make a rights issue equal to the cost of the equipment. The shares are currently quoted on the stock exchange at GH¢2.70 per share and the new shares will be offered to shareholders at GH¢1.90 per share.
Required:
(a) Calculate:
(i) the theoretical ex-rights price per share
(ii) the value of the rights on each existing share
(iii) Existing P/E ratio = GH¢2.70 / GH¢0.15 = 18.0
(b) What are the options available to a shareholder who receives a rights offer from a company?
Answer
(A) Calculations
(i) Number of shares in issue = total earnings/EPS
= GH¢1,200,000 / GH¢0.15 = 8,000,000
Value of the existing shares = 8,000,000 × GH¢2.70 = 21.6
Cash raised from new shares = 3.8
Total = 25.4
Number of shares issued = GH¢3,800,000 / GH¢1.90 per share = 2,000,000 shares
The rights issue is therefore a 1 for 4 rights issue (2,000,000 : 8,000,000)
The number of shares after the issue = 10 million
| Current value of 4 existing shares | (× GH¢2.70) | 10.80 |
|---|---|---|
| Rights issue price of 1 share | 1.90 | |
| Theoretical value of 5 shares | 12.70 | |
| Theoretical ex-rights price | (12.70 / 5) | GH¢2.54 |
(B). (ii) Value of the rights
| Current market value of existing share | 2.70 |
|---|---|
| Theoretical ex-rights price | 2.54 |
| The value of a right | 0.16 |
(C). (iii) Existing P/E ratio = GH¢2.70 / GH¢0.15 = 18.0
The revised profit after tax = GH¢1.8 million
The revised total market value = 18 × GH¢1.8 million = GH¢32.4 million
Therefore, the market value per share =
GH¢32.4 million / 10 million shares = GH¢3.24
(b) The shareholder can do any of the following:
- Buy all the shares offered to him in the rights issue. This would maintain his percentage shareholding in the company.
- Sell the rights. Rights can be sold on the stock market. The theoretical market price is GH¢0.16 for the rights attached to one existing share.
- Buy some of the shares offered to him in the rights issue and sell some rights.
- Do nothing. This is a bad choice. Shareholders will see a fall in the value of their shares because the new shares will be issued at a discount to the current market price. The company may try to sell any rights that are not taken up on behalf of the shareholder, but the shareholder should not rely on getting any money from the company.
- Tags: Equity financing, Rights issue, Shareholder options, Stock market
- Level: Level 2
- Topic: Sources of finance: equity
- Uploader: Samuel Duah