Chapter 8 • Sources of long-term finance
(Problems 8.1 to 8.3 are basic-level problems, whereas problems 8.4 and 8.5 are more
advanced and may contain some practical complications.)8.1*Many businesses issue loan notes, which carry the right for holders to convert them
into ordinary shares in the same business at a later date.
Why might a business choose to issue convertible loan notes rather than make an issue
of equity in the first place?8.2*Most businesses, particularly larger ones, have outstanding claims (financial obliga-
tions) of a wide variety of types from a wide variety of claimants at any given moment.
Why is there this diversity?8.3 Polecat plc has 18 million £0.50 ordinary shares in issue. The current stock market
value of these is £1.70 per share. The directors have decided to make a one-for-three
rights issue at £1.25 each.
Julie owns 3,000 Polecat ordinary shares.
Assuming that the rights issue will be the only influence on the share price:
(a) What, in theory, will be the ex-rights price of the shares (that is, the price of the
shares once the rights issue has taken place)?
(b) For how much, in theory, could Julie sell the ‘right’ to buy one share?
(c) Will it matter to Julie if she allows the rights to lapse (that is, she does nothing)?8.4*Memphis plc has 20 million £0.10 ordinary shares in issue. On 7 June the stock market
closing price of the shares was £1.20. Early on the morning of 8 June, the business
publicly announced that it had just secured a new contract to build some hospitals in
the Middle East. To the business, the contract had a net present value of £4 million. On
9 June the business announced its intention to raise the necessary money to finance
the work, totalling £10 million, through a rights issue priced at £0.80 per share.
Assuming that the events described above were the only influence on the share price,
for how much, in theory, could a shareholder sell the right to buy one of the new shares?8.5 The management of Memphis plc (Problem 8.4) is reconsidering its decision on the
rights issue price. It is now contemplating an issue price of £1 per new share. One of
its concerns is the effect that the issue price will have on the wealth of its existing
shareholders. You have been asked to advise.
Calculate the effect on the wealth of a person who owns 200 shares in Memphis plc
before the rights issue, assuming in turn a rights issue price of £0.80 and £1.00. In each
case make your calculations on the basis both that the shareholder takes up the rights,
and that the shareholder sells the rights.
Taking account of all of the factors, what would you advise Memphis plc to do about
the rights issue price?PROBLEMS
Sample answers to
problems marked with
an asterisk appear in
Appendix 4.