- 20 Marks
FM – Nov 2017 – L3 – Q3 – Financing Decisions and Capital Markets
Calculate theoretical ex-rights price, evaluate shareholder options, discuss EMH implications, and analyze market timing for Peter Plc’s equity financing.
Question
Peter Plc. is a large, listed manufacturing company that is currently considering how best to raise new equity finance. One option is to undertake a public issue of new shares, a course of action recently approved by the shareholders. Alternatively, the company is considering a 1 for 4 rights issue at a 10% discount to the current market price of N5.00 per share.
The company has approached several investment banks regarding the potential new rights issue and public issue. During these discussions, one investment bank stated that the precise timing of a rights issue would be of no consequence. The bank is of the opinion that a public issue of new shares should not be undertaken at the present time. It recommended that if the company wishes to pursue a public issue, it should be deferred for a minimum of six months. The bank explained that, at present, the stock market is significantly undervaluing Peter Plc.’s shares. Consequently, the company would have to issue far more shares to raise the required amount of finance than it would in six months.
The Finance Director of Peter Plc. is uncertain about this and, at a recent board meeting where the matter was discussed, made the following statement:
“According to the Efficient Market Hypothesis, all share prices are correct at all times, with prices moving randomly when new information is publicly announced. The analysts at investment banks are unable to predict future share prices.”
Required:
- (a) Calculate the theoretical ex-rights price per share and the value of the rights per existing share, assuming the company chooses this option. (2 Marks)
- (b) Discuss the alternative courses of action open to the owner of 500 shares in Peter Plc. as regards the rights issue, in each case, determining the effect on the wealth of the investor. (4 Marks)
- (c) Discuss the factors that will influence the actual ex-rights price per share. (4 Marks)
- (d) Discuss the meaning and significance of the three forms of the Efficient Market Hypothesis and, with specific reference to these, discuss both the recommendation that the company waits for six months before undertaking a public issue and the Finance Director’s statement. (10 Marks)
(Total 20 Marks)
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