The steps for valuation of rights issue can be elaborated below:
Usually a company offers rights issue at a price which is lower than the market price of the shares so that existing (i.e., old) shareholders may get the monetary benefit of being associated with the company for a long time. Existing shareholders who have been offered right shares and do not want to purchase these offered shares may renounce their right shares in favour of some other persons within the specified period as mentioned earlier. In such a case, the existing shareholders can make a profit by selling his right to such other person because generally the right shares are offered to the existing shareholders at a price lower than the market price of the shares.
The right to purchase more shares is valuable if the market price of the shares is more than the issue price. An existing shareholder may sell his right with or without selling his existing shareholding. The price of right may, therefore, be either cum-right price or ex-right price. Cum-right price gives the purchaser, besides the ownership of the shares already held, the right to apply for new shares offered by the company whereas ex-right price gives the purchaser only the ownership of the existing shares held by the seller and not the right to apply for additional shares offered by the company. Ex-right price is usually quoted either after the right shares have already been allotted by the company or the time to apply for right shares has expired. This right can be valued in terms of money as below :
(a) Calculate the market value of shares which an existing shareholder is required to have in order to get fresh shares.
(b) Add to the above price paid for the fresh shares.
(c) Find out the average price of existing shares and fresh shares.
(d) The average price of the share should be deducted from the market price and the difference thus ascertained is value of right.
The value of the right can also be calculated by applying the following formula:
R = M-S/N+1
Where, R = Value of one right share
M= Cum-right market price of a share
S=Subscription price or issue price for a new share
N=Number of old shares required to purchase on right share.