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 essentially the weighted average price per share of existing shares and the new right shares issued.

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 encourages the existing shareholders to take up the shares and pay cash to the company.

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:

$$ Theoretical\ Ex \text{-} rights\ Price \\ = \frac{New\ Shares × Issue\ Price + Old\ Shares × Market\ Price}{New\ Shares + Old\ Shares} $$

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

$$ Theoretical\ Ex \text{-} rights\ Price \\ = \frac{3 × 12 + 5 × 15}{3 + 5} \\ ≈ 13.9$$

Hence, the shares are likely to be traded at $13.9 after the new shares have been transferred.

Written by Irfanullah Jan and last modified on