Investors are interested in estimating the theoretical price of a share. The price may be said to be a function of the supply and demand for a stock. This is influenced by future earnings expectations.

The price of a share is theoretically the present value of its future dividend streams. New information that changes future earnings forecasts will also change the share price.

The future dividend payments of a corporation may be constant over time; in this case, the dividend payment is simply divided by the required rate of return to estimate the theoretical share price.

Alternatively, a dividend payment may increase over time. It is assumed that increase will be at a constant growth rate. To calculate the share price, the last dividend is multiplied by one plus the constant growth rate; this is then divided by the required rate of return less the growth rate.

There are other more mechanical issues that affect a company's share price. These include the price adjustments that occur when a share trades ex-dividend. All other things being equal, a cum-dividend share price should fall by the amount of a dividend that is paid.

If a company makes a bonus issue to shareholders, where no new capital is raised, the share price will theoretically fall by the relative proportion of new shares issued.

A similar price adjustment expectation will occur with a share split. A share split changes the number of shares issued by a corporation, again without raising additional capital.

Another reason for an adjustment in a share's price is that, if it has been trading with an entitlement to participate in a rights issue, the theoretical ex-rights price will be lower than the cum-rights price.

A renounceable right has a value in that it can be sold before the rights issue exercise date.

Question:

13 AGL Energy Limited has declared a $0.33 cents per share dividend, payable in one month. At the same time the company has decided to capitalise reserves through a one-for-three bonus issue. The current share price at the close of business on the final cum-dividend date is $16.15.

a. Explain the strategy adopted by the company. In your answer, define the terms 'cum-dividend' and 'ex-dividend'.

b. Calculate the theoretical price of the share after the bonus issue and the dividend payment have occurred.

4 Alumina Limited has a share price of $2.82. The company has made a renounceable rights issue offer to shareholders. The offer is a three-for-ten pro-rata issue of ordinary shares at $2.60 per share.

a. Explain the effect of the offer being renounceable.

b. What is the price of the right?

c. Calculate the theoretical ex-rights share price.

d. Explain why an actual ex-rights price of a share may at times differ from the calculated theoretical price.