What it means
When a company needs to raise money, it sometimes offers existing shareholders the chance to buy additional shares at a discount. This is known as a rights issue.
Because the company is creating more shares and selling them below the current market value, the overall value of the business gets spread more thinly. The theoretical ex-rights price tells us what a single share should be worth on paper once this new batch of shares is officially added to the total count.
Why does this matter for managers and business owners? It helps everyone understand the financial dilution that happens during a capital raise.
Existing shareholders will see their current shares drop in nominal value because the pie is now cut into more pieces, but they also gain the opportunity to buy cheap new shares. Calculating this price beforehand ensures transparency and helps investors decide whether they should exercise their rights, sell them to someone else, or ignore them entirely.
In practice, the actual market price on the day the rights take effect often differs slightly from the theoretical price. Market sentiment, overall economic conditions, and investor demand can push the price up or down.
However, the theoretical price serves as the vital starting baseline for brokers, investors, and company directors to price the new shares fairly and manage expectations during the fundraising process.
In practice
Real-world examples.
Example
TechStart Inc. offers existing investors one new share at 2 pounds for every four held. If the current share price is 10 pounds, the theoretical ex-rights price calculates the new adjusted value of the stock.
Example
Local Bakery Ltd needs funds for a new oven and offers shareholders one discounted share at 50 pence for every two held, when the current market price is 2 pounds. The theoretical price helps investors assess the deal.
Example
A mid-sized logistics firm with a share price of 20 pounds issues rights to buy one share at 15 pounds for every five owned. The theoretical ex-rights price reveals the new blended value per share for institutional funds.
Think of it
“Imagine you own four slices of a large pizza worth 10 pounds each. If you buy a fifth slice at a heavy discount, the total value of the pizza increases, but you now have five slices. Your average slice value drops, just like a share price after a rights issue.
Formula
Calculation
Formula: TERP = [(Current Market Value of Existing Shares) + (Total Money Raised from New Shares)] / (Total Number of Shares After the Issue). Example: A company has 1,000 shares at 10 pounds each (10,000 pounds). It issues 500 new shares at 4 pounds each (2,000 pounds raised). Total value is 12,000 pounds for 1,500 shares. TERP equals 12,000 divided by 1,500, which is 8 pounds per share.Case study
Seen in the real world.
GreenTransit Ltd, a fictional urban delivery fleet, needed 500,000 pounds to upgrade its electric vans. Before the announcement, the company had one million shares trading at 2.00 pounds each, giving a market capitalisation of 2 million pounds. GreenTransit offered shareholders the chance to buy one new share for every two currently held at a discounted price of 1.00 pound each. This meant issuing 500,000 new shares to raise the required 500,000 pounds.
To find the theoretical ex-rights price, financial managers combined the existing value of 2 million pounds with the new cash injection of 500,000 pounds, resulting in a total value of 2.5 million pounds. They then divided this by the new total share count of 1.5 million shares. The resulting theoretical ex-rights price was 1.67 pounds per share. This case study shows how the share price drops from 2.00 pounds to 1.67 pounds, reflecting dilution, while the company successfully secures the funds needed for expansion without taking on bank debt.
Watch out
Common mistakes.
- Assuming the actual market price will match the theoretical ex-rights price exactly on the day of trading.
- Forgetting to include the money raised from the new shares in the numerator of the calculation.
- Believing that share dilution from a rights issue automatically means the company is losing fundamental value.
Questions
People also ask.
Why does the share price drop when a rights issue happens?
The share price drops because the company is issuing more shares and diluting ownership. The total value of the company is spread across a larger number of shares.
Is the theoretical ex-rights price guaranteed in the stock market?
No. It is a mathematical calculation based on existing prices. Actual market trading is influenced by buyer demand, company news, and market sentiment.
What happens if an investor chooses not to take up their rights?
If they ignore their rights, the value of their existing shares usually drops to the theoretical ex-rights price, resulting in a loss of wealth unless they sell their rights in the market.
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