Business Finance · Structure and methods of financing a company

Equity Financing and Share Issues: Ordinary Shares, Rights Issues and IPOs

Updated 11 October 2026 · Fact-checked

Equity financing means raising money by issuing shares. Ordinary shareholders own the company and take the residual profit and risk. Preference shareholders get a fixed dividend with priority. Companies issue shares by IPO, rights issue, placing or bonus issue. For a rights issue, find the ex-rights price as the weighted average of old and new share values.

Understand Equity Financing and Share Issues

A company needs long-term money. One way is to sell ownership. Each share is a small slice of the company. The people who buy it are shareholders. They provide equity finance. They have no right to be repaid on a set date.

Ordinary shares carry the residual claim. They are paid dividends only if the board declares them. They rank last if the company is wound up. In return they usually carry votes and share in all future growth. Because they carry the most risk, investors want the highest return. That is why equity is the most expensive source of finance for the company.

Preference shares sit between debt and ordinary shares. They usually pay a fixed dividend, ranking ahead of ordinary dividends. They usually have no vote unless dividends are in arrears. They can be cumulative, redeemable, or convertible. Dividends are paid from after-tax profit, so there is no tax shield, unlike debt interest.

A company can issue shares in several ways. An IPO (initial public offering) sells shares to the public for the first time and lists the company. A rights issue offers new shares to existing holders in proportion to their holdings, usually at a discount. A private placement sells shares to selected investors, which is faster and cheaper. A bonus issue gives free shares out of reserves. It raises no cash and only splits the same value over more shares.

Raising equity has costs: underwriting and issue fees, and the dilution of control and earnings per share. The cost of equity is the return shareholders require. You can estimate it with the dividend growth model or CAPM. Rights issues protect existing holders from losing control. A discount does not make them poorer, because the share price falls to the ex-rights price.

Key rules to remember

Theoretical ex-rights price (TERP): TERP = (N × cum-rights price + n × issue price) ÷ (N + n); N old shares and n new shares. Use the number of shares in the rights ratio, e.g. 1 new for every 4 held.
Value of a right (per new share): Value of right = TERP − issue price; This is what a right to buy one new share is worth. Per old share, divide by the ratio.
Value of a right (per existing share): Value per existing share = cum-rights price − TERP; The fall in price for each share already held.
Dividend growth model (cost of equity): Ke = D1 ÷ P0 + g; D1 = next dividend, P0 = current ex-dividend price, g = constant growth rate. Assumes constant growth.
CAPM cost of equity: Ke = Rf + β × (Rm − Rf); Rf is the risk-free rate, Rm the market return, β the equity beta.
Bonus issue: Price after bonus = old price × old shares ÷ total shares after bonus; Total value is unchanged, so the price falls in proportion.
Cost of non-redeemable preference shares: Kp = Dividend ÷ Price; No tax adjustment, as preference dividends are not tax deductible.

How to solve Equity Financing and Share Issues questions

Use this method for any question on share issues or the features and costs of equity.

1Identify the instrument: ordinary, preference, rights, bonus, IPO or placing. Say it in your answer.
2List the data: number of shares held, ratio, issue price, current price, funds needed and issue costs.
3For rights or bonus issues, work out the total value before, add any cash raised, then divide by the total shares after.
4Compute TERP, then the value of a right and the effect on a holder's wealth. Show each line.
5For cost of equity questions, choose the model from the data given: dividends and growth point to the dividend model, beta and market data point to CAPM.
6For discussion parts, compare cost, control, risk, flexibility and speed. Link each point to the case.
7State the assumptions: no market reaction to the news, constant growth, funds used at the same return.
8Check that the shareholder's wealth is unchanged before and after a fairly priced rights or bonus issue.

Quickest way: Total value method for rights and bonus issues

When to use it: Use this for any numeric question on rights or bonus issues. It avoids formula errors under time pressure.

Write the holding for a convenient block, for example 4 shares for a 1-for-4 rights issue.
Value the old shares at the cum-rights price.
Add the cash paid for the new shares at the issue price.
Divide the total by the new total number of shares. This is the TERP.
Value of a right = TERP − issue price, per new share.
For a bonus issue, add zero cash and divide by the new share count.

Common mistakes in Equity Financing and Share Issues

Thinking a discounted rights issue makes existing holders worse off.
Students see the share price fall and treat that as a loss.
Fix: Compare total wealth. The shares fall to TERP, but the holder owns more shares or sells the rights. A holder who takes up or sells the rights is no worse off.
Using the issue price as the new share price after the rights issue.
Students forget that old and new shares trade together.
Fix: Calculate TERP as a weighted average. It lies between the issue price and the cum-rights price.
Treating a bonus issue as raising cash.
The word 'issue' suggests new money.
Fix: A bonus issue capitalises reserves. No cash comes in, total value is unchanged, and the price falls in proportion to the new share count.
Claiming preference dividends give a tax shield.
Students mix preference shares with debt.
Fix: Preference dividends are paid from post-tax profit. Only debt interest is deductible, so give no tax adjustment to Kp.
Using the cum-dividend price in the dividend growth model.
Students take the quoted price without checking the dividend status.
Fix: Use the ex-dividend price with D1. If the price is cum-dividend, subtract the dividend about to be paid.
Ignoring issue costs when finding net funds raised.
Students focus on the share price and skip the fees.
Fix: Net proceeds = gross proceeds − issue costs. Use net proceeds when asked how much money the company receives.

Worked examples

Example 1

A company has a share price of ₹200. It announces a 1-for-4 rights issue at ₹160 per share. Calculate the TERP and the value of a right per new share. A holder owns 400 shares. Show that their wealth is unchanged if they take up the rights.

Show the solution

Take a block of 4 old shares and 1 new share.
Value of 4 old shares = 4 × ₹200 = ₹800.
Cash paid for 1 new share = ₹160.
Total value = ₹800 + ₹160 = ₹960 over 5 shares.
TERP = ₹960 ÷ 5 = ₹192.
Value of a right per new share = ₹192 − ₹160 = ₹32.
Holder with 400 shares: wealth before = 400 × ₹200 = ₹80,000.
New shares = 400 ÷ 4 = 100, costing 100 × ₹160 = ₹16,000.
Wealth after = 500 × ₹192 = ₹96,000, less cash paid ₹16,000 = ₹80,000.
Wealth is unchanged.

Answer: TERP = ₹192. The value of a right is ₹32 per new share. The holder's net wealth stays at ₹80,000.

Example 2

A company has 10,00,000 ordinary shares priced at ₹90 each. Its next dividend is expected to be ₹6 per share, growing at 4% a year. Find the cost of equity. The company then makes a 1-for-5 bonus issue. Find the new share price, assuming total value is unchanged.

Show the solution

Dividend growth model: Ke = D1 ÷ P0 + g.
D1 ÷ P0 = 6 ÷ 90 = 0.0667.
Ke = 0.0667 + 0.04 = 0.1067, which is 10.67%.
Bonus issue: 1 new share for every 5 held.
New shares = 10,00,000 ÷ 5 = 2,00,000.
Total shares after = 12,00,000.
Total value = 10,00,000 × ₹90 = ₹9,00,00,000, unchanged.
New price = ₹9,00,00,000 ÷ 12,00,000 = ₹75.

Answer: Cost of equity ≈ 10.67%. The share price after the bonus issue is ₹75.

Exam tips

Show the TERP working in full. Marks are given for method even if the arithmetic slips.
In MCQs on rights issues, check which price the question gives: cum-rights or issue price.
In written answers, compare ordinary and preference shares on dividend, voting, risk, tax and cost. Use a short bullet for each.
State the assumptions in cost of equity answers, such as constant growth or an efficient market.
For discussion questions, tie the choice of IPO, rights issue or placing to the company's size, speed needed and control concerns.

Practice questions from Structure and methods of financing a company

Equity Financing 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 Financing and Share Issues: frequently asked questions

What is the difference between ordinary and preference shares?

Ordinary shareholders get a variable dividend, carry the most risk and normally have votes. Preference shareholders get a fixed dividend ahead of ordinary holders, rank higher in winding up and usually have no vote. Preference dividends are not tax deductible.

How is the ex-rights price calculated?

Add the value of the old shares at the cum-rights price to the cash paid for the new shares. Divide by the total number of shares after the issue. The result is the theoretical ex-rights price.

How do IPOs, rights issues and private placements differ?

An IPO sells shares to the public and lists the company. A rights issue offers shares to existing holders first, which protects their control. A private placement sells to chosen investors, so it is faster and cheaper but narrower.

Why is equity more expensive than debt for a company?

Shareholders bear more risk because they are paid last and have no fixed return. They therefore demand a higher return. Debt interest is also tax deductible, which lowers its cost further.