Financial Management · Sources of finance and their relative costs

Equity Finance and Share Issues for ACCA Financial Management

Updated 11 October 2026 · Fact-checked

Equity finance raises money by selling ordinary shares or by keeping profits. 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 old shares at market price and new shares at the issue price.

Understand Equity Finance and Share Issues

Equity finance is money put in by the owners of a company. A company gets it in two ways: by issuing new ordinary shares, or by keeping profit instead of paying it out as dividends (retained earnings). Equity has no fixed repayment date and no compulsory dividend. Shareholders carry the most risk, so they expect the highest return. That is why equity is the most expensive source of finance.

A listed company has three main ways to issue new shares. A rights issue offers the new shares to existing shareholders in proportion to their holdings, usually at a discount to the market price. A placing sells the shares to a small number of chosen institutional investors. A public offer invites the general public to apply for shares. A public offer is the most costly and slowest. A placing is cheaper and quicker. A rights issue sits in between, and it protects existing shareholders from dilution of their control.

Rights issues are discounted so that shareholders are tempted to take them up. The discount is not a loss to shareholders. After the issue, there are more shares and more cash in the company. The share price falls to a new theoretical level, the TERP. Each right you hold has a value equal to the gain from buying at the issue price instead of the TERP.

Retained earnings are not free. Profit retained belongs to shareholders, who could have received it as dividends and invested it elsewhere. So retained earnings have a cost, which is the cost of equity. They need no issue costs and no new approval from investors, which makes them the cheapest and most convenient equity source. Their limit is the profit available and the dividend expectations of shareholders.

A shareholder facing a rights issue has four choices: take up the rights, sell the rights, take up part and sell the rest to pay for it, or do nothing and let the rights lapse. Doing nothing usually loses value. The first three leave wealth unchanged if the TERP is correct.

Key rules to remember

Theoretical ex-rights price (TERP): TERP = [(N × cum-rights price) + (n × issue price)] ÷ (N + n); N is the number of old shares in the ratio and n is the number of new shares. For a 1 for 4 issue, use 4 old and 1 new.
Value of a right per new share: Value of right per new share = TERP − issue price; This is the gain on each new share bought.
Value of a right per existing share: Value per existing share = (TERP − issue price) × (n ÷ N); Or equivalently: cum-rights price − TERP. Both give the same answer.
Funds raised: Net funds = (new shares × issue price) − issue costs; Issue costs are usually deducted from proceeds, and they do not enter the TERP unless the question says so.
Earnings per share after issue: New EPS = total earnings ÷ (old shares + new shares); Adjust earnings if the funds raised are expected to earn a return.

How to solve Equity Finance and Share Issues questions

Use this method for any rights issue or equity issue question.

1Read the terms. Write the ratio as old shares to new shares (for example, 1 for 5 means N = 5, n = 1). Note the issue price and the current (cum-rights) market price.
2Calculate the TERP. Multiply the old shares by the cum-rights price, add the new shares at the issue price, and divide by the total number of shares.
3Calculate the value of a right. Use cum-rights price − TERP per existing share, or TERP − issue price per new share.
4Calculate funds raised: new shares × issue price, less any issue costs. Count the total new shares from the number of shares in issue.
5If asked about the shareholder, compare the options. Compute the wealth under take-up, sale of rights and lapse, using the same starting position.
6If asked about EPS, earnings or the cost, update the share count and any extra earnings from the funds raised.
7Finish with a short comment if the question asks for one: dilution of control, issue cost, discount level, and the effect on gearing.

Quickest way: Total value approach to TERP

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

Take a bundle of shares that matches the ratio. For 1 for 4, use 4 old shares plus 1 new.
Value the bundle: old shares at the current price plus new shares at the issue price.
Divide the bundle value by the number of shares in the bundle. That is the TERP.
Value of a right per existing share is the current price less TERP. Check by multiplying the per share value by the number of old shares in your bundle. It should equal TERP − issue price.

Common mistakes in Equity Finance and Share Issues

Using the ratio the wrong way round, for example treating 1 for 4 as 1 old and 4 new.
The wording is quick to read and students reverse it.
Fix: Write 'old : new' on your working before you start. 1 for 4 means one new share for every four held.
Using the average of the market price and the issue price as the TERP.
It looks like a simple mean.
Fix: TERP is a weighted average. The weights are the number of old and new shares.
Stating the value of a right per new share when the question asks per existing share, or the other way round.
Both formulas are similar and objective options often include both figures.
Fix: Read the unit asked for. Per existing share = (TERP − issue price) × n ÷ N.
Saying retained earnings are free or have no cost.
No cash is paid out and no issue costs arise.
Fix: State that retained earnings have an opportunity cost equal to the shareholders' required return, which is the cost of equity.
Assuming a rights issue changes shareholder wealth when shareholders take it up or sell the rights.
The share price falls and students see a loss.
Fix: Compare total wealth. The fall in price is offset by the shares bought at a discount or the cash from selling the rights, so wealth is unchanged if the TERP holds.
Mixing up a placing with a rights issue, for example saying a placing is offered to existing shareholders in proportion to holdings.
Both are ways to issue shares to a limited group.
Fix: A rights issue is pro rata to existing shareholders. A placing goes to selected investors, typically institutions, so existing holders may be diluted.

Worked examples

Example 1

Delta plc has 4,000,000 shares in issue, with a current market price of ₹250 per share. It makes a 1 for 4 rights issue at ₹200 per share. Calculate (a) the TERP, (b) the value of a right per existing share, and (c) the funds raised, ignoring issue costs.

Show the solution

Ratio: 4 old shares to 1 new share.
Value of the bundle: 4 × ₹250 = ₹1,000, plus 1 × ₹200 = ₹200. Total = ₹1,200 for 5 shares.
TERP = ₹1,200 ÷ 5 = ₹240.
Value of a right per existing share = ₹250 − ₹240 = ₹10.
Check: TERP − issue price = ₹240 − ₹200 = ₹40 per new share. One new share needs four old shares, so ₹40 ÷ 4 = ₹10. This agrees.
New shares issued = 4,000,000 ÷ 4 = 1,000,000.
Funds raised = 1,000,000 × ₹200 = ₹20,00,00,000.

Answer: (a) TERP = ₹240. (b) Value of a right = ₹10 per existing share. (c) Funds raised = ₹20,00,00,000.

Example 2

Ravi owns 2,000 shares in Delta plc (see the previous example: cum-rights price ₹250, issue price ₹200, 1 for 4 rights issue, TERP ₹240). Show that Ravi's wealth is the same if he (a) takes up his rights in full, or (b) sells all his rights.

Show the solution

Wealth before the issue = 2,000 × ₹250 = ₹5,00,000.
Option (a): Ravi is entitled to 2,000 ÷ 4 = 500 new shares. Cost = 500 × ₹200 = ₹1,00,000.
After take-up he holds 2,500 shares at ₹240 = ₹6,00,000. Subtract the cash paid of ₹1,00,000. Net wealth = ₹5,00,000.
Option (b): He sells 500 rights at ₹40 each? No. The value per right to buy one new share is ₹40, so 500 rights × ₹40 = ₹20,000.
He still holds 2,000 shares at ₹240 = ₹4,80,000. Add cash from sale ₹20,000. Total wealth = ₹5,00,000.
Both options give ₹5,00,000, equal to the starting wealth.

Answer: Wealth is ₹5,00,000 under both options, the same as before the issue, so the discount does not itself make shareholders better or worse off.

Exam tips

In objective questions, wrong options are often the answers from the common slips: a simple average, the wrong ratio, or the value per new share instead of per existing share. Check your result against the unit asked.
Do the bundle method in the margin of your rough paper. It is quick and reduces ratio errors.
In constructed-response answers, show the TERP working line by line. Marks are given for method even if the final figure is slightly wrong.
For discussion parts, compare rights issues, placings and public offers on cost, speed, control and dilution, and tie each point to the company in the scenario.
If a question asks about the effect on EPS or gearing, update the share count or debt level first and state your assumptions about how the funds are used.

Practice questions from Sources of finance and their relative costs

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 I calculate the theoretical ex-rights price in ACCA FM?

Take the number of old shares in the ratio at the cum-rights price and add the new shares at the issue price. Divide the total by the total number of shares. For a 1 for 4 issue at ₹200 with a market price of ₹250, TERP = (4 × ₹250 + 1 × ₹200) ÷ 5 = ₹240.

How do I calculate the value of a right?

Per existing share, it is the cum-rights price minus the TERP. Per new share, it is the TERP minus the issue price. Check which one the question asks for, as the figures differ.

What is the difference between a rights issue and a placing?

A rights issue offers new shares to all existing shareholders in proportion to their holdings, usually at a discount. A placing sells new shares to a small number of selected investors, often institutions. A placing is usually quicker and cheaper but can dilute existing holders.

Are retained earnings a free source of finance?

No. They have no issue costs and no cash payment, but shareholders could have received the profit as dividends. So retained earnings carry an opportunity cost equal to the cost of equity.