Table 169

National Power Company Rights Offering

= 1.5 million. The value of the firm will increase to $20 million + 5 million = $25 million. The value of each share will thus drop to $25 million/1.5 million = $16.67 after 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 difference 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 X 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.

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 Companies, 2002

PART SIX Cost of Capital and Long-Term Financial Policy

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