The Moon Company Ltd. has issued 10,000,000, Sh. 10 par equity shares which are at present selling for Sh. 30 per share. It has also issued 5,000,000 warrants, each entitling the holder to buy one equity share. The warrants are protected against dilution.

The company has plans to issue rights to purchase one new equity share at a price of Sh. 20 per share for every four shares held.

Required:

Calculate the theoretical ex-rights price of Moon Company Ltd.s equity shares. (1 mark)

The theoretical value of a right of the Moon Company Ltd. before the shares sell ex-rights. (2 marks)

The chairman of the company receives a phone call from an angry shareholder who owns 100,000 shares. The shareholder argues that he will suffer a loss in his personal wealth due to this rights issue, because the new shares are being offered at a price lower than the current market value.

The chairman assures him that his wealth will not be reduced because of the rights issue, as long as the shareholder takes appropriate action.

Required:

Explain whether the chairman is correct. What should the shareholder do? (2 marks)

A statement showing the effect of the rights issue on this particular shareholders wealth, assuming:

He sells all the rights.

He exercises one half of the rights and sells the other half.

He does nothing at all. (6 marks)

Are there any real circumstances which might lend support to the shareholders claim? (3 marks)