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.

Ross et al.: Fundamentals I VI. Cost of Capital and I 16. Raising Capital I I © The McGraw-Hill of Corporate Finance, Sixth Long-Term Financial Companies, 2002

Edition, Alternate Edition Policy

548 PART SIX Cost of Capital and Long-Term Financial Policy

At $10 per share, National Power will have to issue 500,000 new shares. This can be determined by dividing the total amount of funds to be raised by the subscription price:

Funds to be raised

Subscription price

Because stockholders always get one right for each share of stock they own, one million rights will be issued by National Power. To determine how many rights will be needed to buy one new share of stock, we can divide the number of existing outstanding shares of stock by the number of new shares:

Number of rights needed Old shares to buy a share of stock New Shares

2 rights

Thus, a shareholder will need to give up two rights plus $10 to receive a share of new stock. If all the stockholders do this, National Power will raise the required $5 million.

It should be clear that the subscription price, the number of new shares, and the number of rights needed to buy a new share of stock are interrelated. For example, National Power can lower the subscription price. If it does, more new shares will have to be issued to raise $5 million in new equity. Several alternatives are worked out here:

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