What is right Issue?

A rights issue is a sale of rights to current shareholders of a company that allows them to purchase additional shares directly from the firm at a discounted price rather than on the secondary market. The amount of extra shares that can be purchased is determined by the shareowners' current holdings. 

"Existing shareholders are invited to purchase additional new shares in the company through a rights issue. Existing shareholders are given securities called rights in this sort of offering. The shareholder can use the rights to buy new shares at a discount to the market price at a specified future period. The corporation is offering shareholders a discounted opportunity to increase their exposure to the stock." "Shareholders can trade the rights on the market in the same manner they would ordinary shares until the new shares are available for purchase. The rights granted to a shareholder have monetary worth, compensating current shareholders for potential dilution of the value of their existing shares. Because a rights issue spreads a company's net profit over a larger number of shares, dilution happens. As a result of the allocated earnings resulting in share dilution, the company's earnings per share, or EPS, declines." What Makes Right Issues Work? "So, how do questions of rights work? Assume you own 1,000 Wobble Telecom shares, each of which is worth $5.50. The business is in financial distress and has to raise funds to pay off its debts. As a result, Wobble has announced a rights offering in which it hopes to generate $30 million by issuing 10 million shares at a price of $3 apiece to existing investors. However, this is a three-for-ten rights issue. In other words, for every ten shares you own, Wobble will give you three more at a steep discount of $3. This is a 45 percent discount to the current Wobble stock price of $5.50. With a rights issue, you have three alternatives as a shareholder. You have the option of (1) fully subscribing to the rights issue, (2) ignoring your rights, or (3) selling your rights to someone else. We'll go over each option and the various outcomes below." "So, how do questions of rights work? Assume you own 1,000 Wobble Telecom shares, each of which is worth $5.50. The business is in financial distress and has to raise funds to pay off its debts. As a result, Wobble has announced a rights offering in which it hopes to generate $30 million by issuing 10 million shares at a price of $3 apiece to existing investors. However, this is a three-for-ten rights issue. In other words, for every ten shares you own, Wobble will give you three more at a steep discount of $3. This is a 45 percent discount to the current Wobble stock price of $5.50. With a rights issue, you have three alternatives as a shareholder. You have the option of (1) fully subscribing to the rights issue, (2) ignoring your rights, or (3) selling your rights to someone else. We'll go over each option and the probable results below. 1. Take full advantage of your right to purchase. To fully benefit from the rights issue, you'd have to pay $3 for each Wobble share you're eligible to buy under the terms of the deal. If you possess 1,000 shares, you can acquire up to 300 new shares at a discounted price of $3 each (three for every ten you already own), for a total cost of $900. The market price of Wobble shares will not be $5.50 after the rights offer is completed, notwithstanding the 45 percent discount on freshly issued shares. As a result of the increased number of shares issued, the value of each share will be diluted. To determine if the rights issuance provides a meaningful discount, calculate how much Wobble's share price will be diluted. When calculating this dilution, keep in mind that the future value of your extended shareholding is always uncertain due to company and market circumstances. However, the ex-rights share price—the imaginary share price that will result once the rights issue is completed—can be calculated. Divide the total price you'll have spent for all of your Wobble shares by the entire number of shares you'll own to get this price. The following formula is used to determine this: So, in theory, the value of each of your current shares will fall from $5.50 to $4.92 as a result of the introduction of new shares at a severely discounted price. However, keep in mind that the loss on your previous shareholding is completely compensated by the gain in share value on the new rights: the new shares cost $3 but have a market worth of $4.92. These new shares are taxed in the same year as the original shares and are carried forward to count as investment income, but there are no interest or other tax penalties on this taxable investment income that has been carried forward."

Citation: