Financial management revision question and answer

Gopher Ltd has issued 300,000 ordinary shares of £1 each, which are at present selling for £4 per share. The company plans to issue rights to purchase one new equity share at a price of £3.20 per share for every 3 shares held. A shareholder who owns 900 shares thinks that he will suffer a loss in his personal wealth because the new shares are being offered at a price lower than market value. On the assumption that the actual market value of shares will be equal to the theoretical ex-rights price, what would be the effect on the shareholder‟s wealth if:

(a) He sells all the rights;
(b) He exercises one half of the rights and sells the other half;
(c) He does nothing at all?

The shareholder would neither gain nor lose wealth, although he will have increased his investment in the company £480.
(c) If the shareholder does nothing, but all other shareholders either exercise their rights or sell them, he will lose wealth as follows:

It therefore follows that the shareholder, to protect his existing investment, should either exercise his rights or sell them to another investor.

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