Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

VI. Cost of Capital and

Long−Term Financial

Policy

16. Raising Capital © The McGraw−Hill^577
    Companies, 2002

1.5 million. The value of the firm will increase to $20 million5 million $25 mil-
lion. The value of each share will thus drop to $25 million/1.5 million $16.67after
the rights offering.
The difference between the old share price of $20 and the new share price of $16.67
reflects the fact that the old shares carried rights to subscribe to the new issue. The dif-
ference must be equal to the value of one right, that is, $20
16.67 $3.33.
An investor holding no shares of outstanding National Power stock who wants to
subscribe to the new issue can do so by buying some rights. Suppose an outside investor
buys two rights. This will cost $3.33  2 $6.67 (to account for previous rounding). If
the investor exercises the rights at a subscription price of $10, the total cost will be $10
6.67 $16.67. In return for this expenditure, the investor will receive a share of the
new stock, which, as we have seen, is worth $16.67.

CHAPTER 16 Raising Capital 549

TABLE 16.8

The Value of Rights: The

Individual Shareholder

Initial Position

Number of shares 2

Share price $20

Value of holding $40

Terms of Offer

Subscription price $10

Number of rights issued 2

Number of rights for a new share 2

After Offer

Number of shares 3

Value of holding $50

Share price $16.67

Value of one right: Old price 
New price $20 
16.67 $3.33

TABLE 16.9

National Power

Company Rights

Offering

Initial Position

Number of shares 1 million

Share price $20

Value of firm $20 million

Terms of Offer

Subscription price $10

Number of rights issued 1 million

Number of rights for a new share 2

After Offer

Number of shares 1.5 million

Share price $16.67

Value of firm $25 million

Value of one right $20 
16.67 $3.33