The management of Memphis plc (Problem 8.4 ) is reconsidering its decision on the rights issue price. It is now contemplating an issue price of £1 per new share. One of its concerns is the effect that the issue price will have on the wealth of its existing shareholders.

You have been asked to advise.

Calculate the effect on the wealth of a person who owns 200 shares in Memphis plc before the rights issue, assuming in turn a rights issue price of £0.80 and £1.00. In each case make your calculations on the basis both that the shareholder takes up the rights and that the shareholder sells the rights.

Taking account of all of the factors, what would you advise Memphis plc to do about the rights issue price?

Data from Problem 8.4

Memphis plc has 20 million £0.10 ordinary shares in issue. On 7 June the stock market closing price of the shares was £1.20. Early on the morning of 8 June, the business publicly announced that it had just secured a new contract to build some hospitals in the Middle East. To the business, the contract had a net present value of £4 million. On 9 June the business announced its intention to raise the necessary money to finance the work, totalling £10 million, through a rights issue priced at £0.80 per share.

Assuming that the events described above were the only influence on the share price, for how much, in theory, could a shareholder sell the right to buy one of the new shares?