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ACCA Strategic Professional · Strategic Business Leader · Financial analysis and decision-making techniques

Pelham Foods needs USD 20 million to fund an expansion. Its shares are quoted, its directors expect the share price to be undervalued by the market for the next year, and existing shareholders have strong pre-emption expectations. Which approach to raising equity is most consistent with these circumstances?

A rights issue is the best fit. It offers new shares to existing shareholders in proportion to their holdings, respecting pre-emption expectations and preventing value leaking to new investors while the shares are undervalued. Placings or public offers would sell undervalued shares to outsiders, and issuing to directors only is unfair.

  1. AA rights issue, since shareholders keep their proportionate ownership and can take up shares at a discount to the market priceCorrect
  2. BA public offer at a premium to the market price to new investors
  3. CA placing at a price above the current market price
  4. DIssuing irredeemable preference shares to existing directors only

Explanation

A rights issue respects pre-emption, so if shares are undervalued existing holders, not new investors, benefit from the discounted price and avoid value transfer. A public offer or placing to new investors would transfer value to them at an undervalued price, and a premium pricing is unrealistic when the market undervalues the shares. Issuing preference shares to directors only fails the shareholder fairness expectation.

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