Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate Edition
VI. Cost of Capital and
Long−Term Financial
Policy
- Raising Capital © The McGraw−Hill^575
Companies, 2002
To execute a rights offering, the financial management of National Power will have
to answer the following questions:
- What should the price per share be for the new stock?
- How many shares will have to be sold?
- How many shares will each shareholder be allowed to buy?
Also, management will probably want to ask:
- What is likely to be the effect of the rights offering on the per-share value of the
existing stock?
It turns out that the answers to these questions are highly interrelated. We will get to
them in just a moment.
The early stages of a rights offering are the same as those for the general cash offer.
The difference between a rights offering and a general cash offer lies in how the shares
are sold. In a rights offer, National Power’s existing shareholders are informed that they
own one right for each share of stock they own. National Power will then specify how
many rights a shareholder needs to buy one additional share at a specified price.
To take advantage of the rights offering, shareholders have to exercise the rights by
filling out a subscription form and sending it, along with payment, to the firm’s sub-
scription agent (the subscription agent is usually a bank). Shareholders of National
Power will actually have several choices: (1) exercise their rights and subscribe for
some or all of the entitled shares, (2) order some or all of the rights sold, or (3) do noth-
ing and let the rights expire. As we will discuss, this third course of action is inadvisable.
Number of Rights Needed to Purchase a Share
National Power wants to raise $5 million in new equity. Suppose the subscription price
is set at $10 per share. How National Power arrives at that price is something we will
discuss later, but notice that the subscription price is substantially less than the current
$20 per share market price.
CHAPTER 16 Raising Capital 547
TABLE 16.7
National Power
Company Financial
Statements Before
Rights Offering
NATIONAL POWER COMPANY
Balance Sheet
Assets Shareholders’ Equity
Assets $15,000,000 Common stock $ 5,000,000
Retained earnings 10,000,000
Total $15,000,000 Total $15,000,000
Income Statement
Earnings before taxes $ 3,030,303
Taxes (34%) 1,030,303
Net income $ 2,000,000
Shares outstanding 1,000,000
Earnings per share $ 2
Market price per share $ 20
Total market value $20,000,000