Chapter 8

FIGURE 8.1 PROJECT RISK AND RETURNFIGURE 8.2 PARTICULAR REINVESTMENT RETURN REQUIREMENTS

WORKING INSIGHT 8.6 IMPACT OF RIGHTS ISSUES ON SUBSTANTIAL SHAREHOLDERS

WORKING INSIGHT 8.9A BONUS ISSUE AND A SHARE SPLIT

FIGURE 8.1 PROJECT RISK AND RETURN

Project Risk

Project Expected

Return

Project risk-return line

A

B

Company cost of capital

Company overall risk

factorProject A should be accepted

Project B should be rejected

FIGURE 8.2 PARTICULAR REINVESTMENT RETURN REQUIREMENTS

Project Risk

Project Expected

Return

Increasing return

Company cost of capital

Company overall risk

factor

Minimum return

Foregone low-risk

opportunities

WORKING INSIGHT 8.6 IMPACT OF RIGHTS ISSUES ON SUBSTANTIAL SHAREHOLDERS

TAKING UP THE RIGHTSOriginal investment is 100m @ 50p =

50.00mPaid for new shares: 25m @ 45p =

11.25m

So the shareholder now owns 125m shares, and has 11.25m less cash than previously.

125m @ 49p gives an investment value of £61.25m

Less, the cash paid of £11.25m

Net value to the shareholder is 61.25 – 11.25 = £50m

SELLING THE RIGHTSOriginal investment is 100m @ 50p =

50.00mSell each right @ [49 – 45] = 4p per shareReceive 25m @ 4p = £1m

So the shareholder now owns 100m shares valued at 49p = £49m

Plus, she has cash to the value of £1m

Total value to the shareholder is £50m

Holder of 100m shares trading at 50p has the right to buy another 25m shares @ 45p each in a one-for-four rights issue.

Theoretical post-right price is ([50p x 4] + 45p) / 5 = 49p per share

WORKING INSIGHT 8.9A BONUS ISSUE AND A SHARE SPLIT

BonusCo SplitCo

Capital structure prior to transaction

Share capital

100000 shares @ £1 par value 100 000 100 000

Retained profits 250 000 250 000

350 000 350 000

After a bonus issue of one for four shares:

Share capital

125000 shares @ £1 par value 125 000

Retained profits 225 000

350 000

After an 1.25 for one share split:

Share capital

125000 shares @ 80 p par value 100 000

Retained profits 250 000

350 000