Ex-Rights Price Calculator (rights issue & bonus issue)

Understanding the ex-rights price calculator — concept and principle

When a company raises money through a rights issue, existing shareholders may buy new shares at a discount, usually in proportion to what they hold. In a bonus (capitalisation) issue they receive new shares free. Either way, the share price normally adjusts on the ex-date. This calculator estimates the theoretical ex-rights price (TERP), the value of the right attached to each old share, the expected price drop and how many shares you hold afterwards.

How it is calculated

With cum-rights price P, ratio r (new shares per old share) and subscription price S:

• TERP = (P + r × S) ÷ (1 + r)
• Value of one right (per old share) = P − TERP
• Price drop = TERP ÷ P − 1
• Shares after, per 100 held = 100 × (1 + r)

For a bonus issue S = 0, so TERP = P ÷ (1 + r). A 1-for-4 issue is r = 0.25; a 1-for-1 bonus is r = 1.

The principle

TERP is a weighted average. Before the issue, each old share is worth P. Afterwards, the holder of one old share also owns r new shares paid for at S, so the total value P + r × S is spread over 1 + r shares. The company has received fresh cash but nothing else changed, so the market value per share falls to that average. In a bonus issue no cash comes in at all; the same company is just cut into more pieces. The right has value because it lets you buy below the market price; a holder who neither takes up nor sells the right loses that value.

Worked example

1. Price before the issue $20, ratio 0.25 (one new share for every four held), subscription price $15.
2. TERP = (20 + 0.25 × 15) ÷ 1.25 = 23.75 ÷ 1.25 = $19.00.
3. Value of one right = 20 − 19 = $1.00 per old share.
4. Price drop = 19 ÷ 20 − 1 = −5%.
5. Shares after, per 100 held = 100 × 1.25 = 125.

Check: four old shares plus one new share cost 4 × 20 + 15 = $95 for five shares, which is $19 each.

How to read the result

The drop on the ex-date is not a loss for a shareholder who takes up the right, because the extra shares make up for it. The deeper the discount, the lower the TERP and the more valuable each right. If the market price ends up below TERP, the market is pricing in more than the mechanics of the issue, such as doubts about how the money will be used.

Common mistakes

• Writing the ratio upside down: 1-for-4 is 0.25, not 4.
• Treating the price drop on the ex-date as a market crash.
• Forgetting to sell or exercise the rights before they expire.

Frequently asked questions

What is the price after a 1-for-1 bonus issue at $20?

About $10, because the same value is spread over twice as many shares.

Do I lose money in a rights issue if I do nothing?

You can, because your stake is diluted and the value of the right is lost unless you sell it or take it up.

Why is the subscription price set below the market price?

To encourage take-up and to leave a margin if the share price falls during the offer.

Sources: CFA Institute, Corporate Issuers curriculum (rights offerings) · R. A. Brealey, S. C. Myers, F. Allen, Principles of Corporate Finance, McGraw-Hill