Theoretical Ex-rights Price
Theoretical ex-rights price (TERP) is the estimated price of a share of a company following a rights issue. It is usually estimated as the weighted average price per share of existing and the new shares.
Rights issue is the issue of new shares for cash to the current shareholders of a company. Right shares are issued at a price slightly below the market price of shares prevailing at the time. This is done to encourage the existing shareholders to take up the shares and pay cash to the company. Therefore, theoretical ex-rights price is usually lower than the share price before the rights issue.
The existing shareholders obtain rights in proportion to their existing shareholding. Say for example each 1 share you own gets you a right to 1 new share being issued. This is called a 1 for 1 right issue. Right issue may be done in any proportion, for example 1 for 4 right issue, 2 for 5 right issue etc.
Formula
Simple weighted average formula to estimate theoretical ex-rights price is:
| Theoretical Ex-rights Price | |
| = | New Shares × Issue Price + Old Shares × Market Price |
| New Shares + Old Shares | |
Example
A 3 for 5 rights issue was announced by a company at $12 for each new share issued. The current market price per share is $15. Estimate the price per share after the shares have been taken up by the shareholders.
Solution
| Theoretical Ex-rights Price | ||
| = | 3 × 12 + 5 × 15 | ≈ 13.9 |
| 3 + 5 | ||
Hence, the shares are likely to be traded at $13.9 after the new shares have been issued.
by Irfanullah Jan, ACCA and last modified on