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The firm XYZ makes a public announcement that it will raise equity finance through a rights issue of new shares to existing shareholders to finance

The firm XYZ makes a public announcement that it will raise equity finance through a rights issue of new shares to existing shareholders to finance a new project with a net present value of $9.8 million and an investment cost of $25.2 million. There will be 15 million rights issue shares, priced at $1.68 each. Assume that before making public the information about the new project or its financing, the firm had 30 million shares with a market value of $1.95 per share.

The market is semi-strong form efficient and there are no issue costs.

a) What is the value of a share in XYZ after the rights issue?

b) What is the value of a right to obtain one of the rights issue shares? Why?

c) You are an investor who owns 1% of the shares of XYZ. You are offered 1% of the rights issue shares.

i. Assume you buy all of the rights issue shares offered to you. What is the change in your wealth after the rights issue, compared to the value of your shareholding before the public announcement was made?

ii. What will be the change in your wealth, assuming you choose to buy half of the rights issue shares offered to you and sell the rights to buy the other half? Is this different to your answer in (i)? Why/why not?

iii. What will be the change in your wealth if you choose not to buy any rights issue shares or sell any of your rights?

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