Financial Management · Sources of, and raising, business finance

Equity Finance, Rights Issues and TERP for ACCA FM

Updated 11 October 2026 · Fact-checked

Equity finance raises money from ordinary shareholders, either through new shares or retained earnings. In a rights issue, existing shareholders get the first chance to buy new shares at a discount. The theoretical ex-rights price (TERP) is the weighted average of the old shares at the market price and the new shares at the issue price.

Understand Equity Finance and Share Issues

Equity finance is money put into a company by its ordinary shareholders. Ordinary shareholders own the company, vote on key decisions and receive dividends only if the directors declare them. They are paid last if the company fails, so they carry the most risk and expect the highest return.

There are two main sources. The first is retained earnings: profit the company keeps instead of paying out. It is cheap and fast, needs no issue costs and needs no new investors. But it is not free. Shareholders could have received the cash and invested it elsewhere, so they expect a return on it. The amount is also limited by profits and dividend policy.

The second source is issuing new shares. A company that is already listed has three main routes. A rights issue offers the new shares to existing shareholders in proportion to their holdings, usually at a discount to market price. A public offer invites the general public to subscribe. A placing sells the shares directly to a small number of institutional investors, often through an intermediary. Placings are quicker and cheaper than other methods. A rights issue protects existing control and ownership proportions, because shareholders keep their share if they take up their rights.

A rights issue at a discount does not make shareholders worse off by itself. After the issue there are more shares, so the market price falls to a blend of the old price and the issue price. This is the theoretical ex-rights price (TERP). The value of a right is the difference between TERP and the issue price. Shareholders can take up the rights, sell them, or let them lapse, which usually loses value.

A stock market listing gives access to large amounts of capital, makes shares easier to trade and raises the company's profile. The drawbacks are the cost of the listing, strict regulation and disclosure rules, pressure for short-term results and the risk of takeover.

Key rules to remember

Theoretical ex-rights price (TERP): TERP = [(N × cum-rights price) + (M × issue price)] ÷ (N + M); N is the number of old shares and M is the number of new shares in the offer. A '1 for 4' issue means N = 4, M = 1.
Value of a right per new share: Value of right = TERP − issue price; This is what a right is worth for each new share bought. Use it when the question asks about selling rights.
Value of a right per existing share: Value per existing share = (TERP − issue price) × (M ÷ N); Use when a shareholder sells rights relating to the shares already held.
Funds raised: Net funds = (new shares × issue price) − issue costs; Deduct issue costs when the question gives them.
Rights issue price from required funds: New shares = funds needed ÷ issue price; Then work out the ratio of new shares to old shares.
Earnings per share after issue: New EPS = Total earnings ÷ total shares after issue; Add any extra earnings from the new investment. Compare with old EPS to judge dilution.

How to solve Equity Finance and Share Issues questions

Use this method for any rights issue question. Write every figure down, because the marks are for the working as well as the answer.

1Read the offer terms. Write down the ratio (such as 1 for 5), the issue price and the current share price.
2Set N as the number of old shares and M as the number of new shares in the ratio.
3Calculate TERP using the weighted average of N shares at the current price and M shares at the issue price.
4Find the value of a right per new share as TERP minus the issue price. Convert to per existing share by multiplying by M ÷ N if asked.
5Calculate the funds raised: total new shares × issue price. Deduct issue costs if given.
6Check the effect on a shareholder. Compare wealth if they take up rights, sell rights or do nothing.
7If asked about EPS, calculate total shares after the issue and divide earnings by that number.
8Add short comments if the question asks for discussion: control, cost, speed, shareholder reaction.

Quickest way: Four-line TERP shortcut

When to use it: Use in Section A and Section B objective questions where you only need TERP or the value of a right and time is short.

Write the ratio as N old and M new. Imagine you hold N shares.
Value N shares at the current price. Add M shares at the issue price.
Divide the total by N + M. That is TERP.
Value of a right per new share is TERP minus issue price. Check that TERP lies between the issue price and the old price.

Common mistakes in Equity Finance and Share Issues

Using the issue price as the share price after the issue.
Students think new shares set the market price.
Fix: The market price after the issue is TERP, a weighted average of old price and issue price.
Mixing up N and M in the weighted average.
The ratio '1 for 4' is read the wrong way round.
Fix: '1 for 4' means one new share for every four held, so N = 4 and M = 1. Check TERP lies closer to the old price when N is larger.
Treating retained earnings as a free source of finance.
No cash is paid out and there are no issue costs.
Fix: State that shareholders expect a return on retained funds, so they have a cost of equity.
Forgetting issue costs when finding funds raised.
Students rush to the multiplication and ignore the costs line.
Fix: Underline issue costs in the question. Deduct them to find net proceeds.
Saying a discounted rights issue makes shareholders worse off.
The share price falls after the issue.
Fix: Show that a shareholder who takes up or sells rights keeps their wealth. The fall in price is offset by the extra shares or the value of the rights.
Confusing a rights issue with a public offer or placing.
All three raise cash from new shares.
Fix: Rights issue: existing shareholders first. Public offer: general public. Placing: selected institutions.

Worked examples

Example 1

A company has 4,00,000 shares in issue, currently priced at ₹3.00 each. It makes a 1 for 4 rights issue at ₹2.00 per share. Calculate the TERP, the value of a right per new share and the funds raised before costs.

Show the solution

Ratio 1 for 4: N = 4, M = 1.
Value of 4 old shares = 4 × ₹3.00 = ₹12.00.
Value of 1 new share at issue price = ₹2.00.
Total = ₹14.00 for 5 shares, so TERP = ₹14.00 ÷ 5 = ₹2.80.
Value of a right per new share = ₹2.80 − ₹2.00 = ₹0.80.
New shares = 4,00,000 ÷ 4 = 1,00,000.
Funds raised = 1,00,000 × ₹2.00 = ₹2,00,000.

Answer: TERP = ₹2.80; value of a right = ₹0.80 per new share; funds raised = ₹2,00,000 before issue costs.

Example 2

An investor holds 1,000 shares in the company in the previous example (price ₹3.00, 1 for 4 rights issue at ₹2.00, TERP ₹2.80). Show that the investor's wealth is the same whether they take up the rights or sell them.

Show the solution

Wealth before the issue = 1,000 × ₹3.00 = ₹3,000.
Rights entitlement = 1,000 ÷ 4 = 250 new shares.
Option 1, take up rights: cost = 250 × ₹2.00 = ₹500. Shares held = 1,250 at TERP ₹2.80 = ₹3,500. Net wealth = ₹3,500 − ₹500 = ₹3,000.
Option 2, sell rights: value per new share = ₹0.80, so sale proceeds = 250 × ₹0.80 = ₹200. Remaining 1,000 shares at ₹2.80 = ₹2,800. Total = ₹2,800 + ₹200 = ₹3,000.
Both options give ₹3,000, equal to wealth before the issue.

Answer: Wealth is ₹3,000 under both options, so the discount does not reduce wealth for a shareholder who takes up or sells rights.

Exam tips

In objective questions, check that your TERP lies between the issue price and the old price. If it does not, you have mixed up N and M.
Show the weighted-average working in constructed response answers. Method marks are available even if the arithmetic slips.
When asked to discuss methods of issue, compare on cost, speed, control and the effect on existing shareholders. Do not just list definitions.
When asked about listing, give both advantages and disadvantages. Use the scenario facts, such as the company's size and plans.
Read whether the question wants the value of a right per new share or per existing share. The two differ by the factor M ÷ N.

Practice questions from Sources of, and raising, business finance

Equity Finance and Share Issues in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Equity Finance and Share Issues: frequently asked questions

How do you calculate TERP in ACCA FM?

Multiply the number of old shares by the current price, add the number of new shares times the issue price, then divide by the total number of shares after the issue. For a 1 for 4 issue, use 4 old and 1 new. The result is the expected market price after the issue.

What is the difference between a rights issue and a public offer?

A rights issue is offered only to existing shareholders in proportion to their holdings, so control is kept. A public offer is open to the general public, so ownership can change. Rights issues are usually made at a discount, and shareholders can sell their rights.

Why are rights issues usually priced at a discount?

The discount makes the offer attractive and helps ensure that the issue is fully taken up even if the share price falls before the closing date. The discount does not harm shareholders who take up or sell their rights, because the share price adjusts to TERP.

What are the advantages and disadvantages of a stock market listing?

Advantages include access to large capital pools, easier trading of shares and a higher profile. Disadvantages include listing and compliance costs, strict disclosure rules, pressure for short-term performance and greater takeover risk.

Is retained earnings a free source of finance?

No. It has no issue costs and needs no new investors, but shareholders expect a return on the profit kept in the business. That expected return is the cost of equity.