LECTURE EXERCISE – CHAPTER 4

Endo Berhad currently has 4 million shares issued and outstanding, valued at RM2.00
each, and the company has annual earnings equal to 20% of the market value of the
shares. A two for five rights issue is proposed at an issue price of RM1.65 each.
If the market continues to value the shares on a price/earnings ratio of 5, what would
be the value per share if the new funds are expected to earn, as a percentage of the
money raised:
(i) 15%,
(ii) 20%, and
(iii) 25%.
(iv) How would these values from (i), (ii) and (iii) compare with the theoretical ex-
rights price? Explain the differences.

SUGGESTED ANSWER
Step 1: Find the theoretical ex-rights price
Five existing shares at cum-rights price @
RM2.00/share RM10.00
Two new shares at issue price of RM1.65/share RM 3.30
Seven shares will have a theoretical value of RM13.30
Theoretical ex-rights price RM13.30/7 RM1.90 per share

Step 2: Find total earnings after rights issue

Existing earnings 20%  4,000,000  RM2 RM 1,600,000

New funds raised from 4,000,000  (2/5)  RM1.65

RM2,640,000

rights issue

Earnings as a % of Additional earnings on Existing Total earnings

new funds raised new funds raised earnings after rights issue
RM RM RM
(i) 15% 396,000 1,600,000 1,996,000
 (ii) 20% 528,000 1,600,000 2,128,000
(iii) 25% 660,000 1,600,000 2,260,000

Step 3: Find total market value of equity and market price per share after rights issue, given a
P/E ratio of 5
Total earnings after rights Total market value of equity Market price per share after
issue after rights issue rights issue
RM RM RM
(i) 1,996,000 9,980,000 1.78
(ii) 2,128,000 10,640,000 1.90
(iii) 2,260,000 11,300,000 2.02

If the additional funds from rights issue raised are expected to earn the same rate
as existing funds, the actual market price per share will be equal to the
theoretical ex-rights price per share.

If the additional funds from rights issue raised are expected to earn a higher rate
than existing funds, the actual market price per share will be above the
theoretical ex-rights price per share.

If the additional funds from rights issue raised are expected to earn a lower rate
than existing funds, the actual market price per share will be below the
theoretical ex-rights price per share