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CT2- April 2014, q14 IFoA

B

Bharti Singla

Senior Member
A quoted company is planning to make a right issue on the basis of one new share for every seven shares currently held. The present share price is $5.20. The right issue price is $4.50 The directors intend to use the funds raised to fund a project that they are confident will increase the company's present market capitalization by 20%
Calculate the expected price per share after the right issue.

Please anyone help me with this qus. I didn't get the working of the qus as why they have only increased the value before right issue by 20%? The value of the co. will be increased by 20% after the right issue, then why they haven't taken into account the new shares?

Please reply asap.
Thank you
 
The question states that the project "will increase the company's present market capitalisation by 20%". So, think of it as two steps;
1. value of company increases by 20% (share price moves to £5.20 x 1.2)
2. now a 1:7 rights issue at £4.50
Calculate the resulting share price as normal.

Note that this assumes the market accepts the company's story about the value of the new project!
 
Simon James said:
The question states that the project "will increase the company's present market capitalisation by 20%". So, think of it as two steps;
1. value of company increases by 20% (share price moves to £5.20 x 1.2)
2. now a 1:7 rights issue at £4.50
Calculate the resulting share price as normal.

Note that this assumes the market accepts the company's story about the value of the new project!
Click to expand...

I'm disappointed with the wording of this question. I feel that you cant just suggest you are confident that the rights issue will increase the market capitalisation by x% (or can you? And is the commonly done in practice?) I did not take this into account and I calculated the new share price as £5.11. How badly was this penalised?
 
I think you're right that it's unlikely anyone could be truly confident that the market cap will increase by x%. However, in terms of the wording of this question, they're evidently confident enough to give us a definite number to use in our calculations. I suspect that multiple choice is an all-or-nothing in the exam, and that we did have to use the 20% increase to pick the correct response.
 
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