Carpets Direct plc wishes to increase the number of its retail outlets in the south of England. The board of directors has decided to finance this expansion programme by raising the funds from existing shareholders through a one-for-four rights issue. The most recent income statement of the business is as follows:

Income statement for the year ended 30 April

£m Sales revenue 164.5 Operating profit 12.6 Interest ( 6.2)

Profit before taxation 6.4 Tax ( 1.9)

Profit for the year 4.5 An ordinary dividend of £2.0 million was proposed and paid during the year.

The share capital of the business consists of 120 million ordinary shares with a par value of

£0.50 per share. The shares of the business are currently being traded on the Stock Exchange at a price/earnings ratio of 22 times and the board of directors has decided to issue the new shares at a discount of 20 per cent on the current market value.

Required:

(a) Calculate the theoretical ex-rights price of an ordinary share in Carpets Direct plc.

(b) Calculate the price at which the rights in Carpets Direct plc are likely to be traded.

(c) Identify and evaluate, at the time of the rights issue, each of the options arising from the rights issue to an investor who holds 4,000 ordinary shares before the rights announcement.