Advanced financial management revision question and answer

Advanced Financial Management Block Revision Mock Exams

A local supermarket chain wishes to increase the number of its retail outlets in the country. The board of directors of the company have decided to finance the acquisition raising funds from the existing shareholders through a one for four rights issue. The recently published income statement of the company for the year ended 31 October 2002 has the following information:
The share capital of the company consists of 12 million ordinary shares with a par value of Sh.5 per share. The shares of the company are currently being traded on the Stock Exchange with a price/earnings ratio of 22 times. The board of directors has decided to issue the shares at a discount of 20 per cent on the current market value.

a) The theoretical ex-rights price of an ordinary share of the company.
b) The price at which the rights in the company are likely to be traded.
c) Assuming an investor held 4,000 ordinary shares of the company before the rights issue announcement, evaluate the following options and identify the best option to the investor.
i) Exercise the rights.
ii) Sell the rights
iii) Do nothing.
a) Since the current MPS is not given, compute the MPS from Earnings Per Share (EPS) and P/E ratio.

The subscriptions/issue price for a rights issue is 90% of MPS (at 10% discount) Use price = 90% x 12.32 = 11.09

c) i)Exercise the right and buy new shares @ Sh.11.09 each.

Sell the rights

She has 4000 rights/shares to enable her to buy 1000 new shares therefore

iii) Do nothing
She will have 4000 shares each valued at ex-right MPS of 12.07 = Sh.48,280

If she exercises the right or sells the rights, the wealth does not change. The difference in the above figures is due to approximation error.

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