TERP - Theoretical Ex Rights Price
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1. Meaning
Theoretical Ex-Rights Price is a deemed value which is attributed to a company's share immediately after a rights issue transaction occurs.
2. Explanation
Theoretical Ex-Rights Price (TERP) denotes the 'theoretical' worth of a single share of a company immediately after a rights issue.
TERP is lower than the market value of a share prior to the rights issue because shares under rights issue transactions are normally issued at a price below the prevailing market price. TERP assumes that all rights are exercised on a single day.
Theoretical Ex-Rights Price may differ slightly from the actual market price of the stocks prevailing after a rights issue due to, for example, varying perceptions of market participants concerning the rights issue and stock market imperfections.
| Theoretical Ex-Rights Price | = | Market Value of shares prior to rights issue + Cash raised from rights issue |
| Number of shares after rights issue |
4. Example
ABC PLC issued 1 for 4 rights shares on 31st March 2013 at an exercise price of $1. Market value of its shares immediately prior to the rights issue was $1.5 per share. ABC PLC had 1 million shares before the issuance of rights shares. All rights were exercised by shareholders on 31st March 2012.
Theoretical Ex-Rights Price may be calculated as follows:
| Step 1: Calculate market value of ABC PLC prior to the rights issue |
| Market Value before rights issue | ($1.5 x 1 million shares) | $1,500,000 |
|
| Step 2: Calculate cash proceeds raised from the rights issue |
| Cash raised from rights issue | ($1 x 250,000*) | $250,000 |
| *(1 million / 4 = 250,000 rights shares) |
|
| Step 3: Calculate number of shares after the rights issue |
| Number of Shares | (1 million + 250,000 [step 2]) | 1,250,000 |
Step 4: Calculate Theoretical Ex-Rights Price
| Theoretical Ex-Rights Price | = | $1,500,000 (Step 1) + $250,000 (Step 2) | = | $1.4 per share |
| 1,250,000 (Step 3) |
5. Rationale
Value of a company's shares represents the present value of future cash flows expected to be earned from the share in the form of dividends and capital gains from future share price appreciation. 'Theoretically' therefore, the value of a company's shares after a rights issue must equal its fraction of the sum of market capitalization immediate prior to rights issue and the cash inflows generated from the rights issue.
5. Importance
Theoretical Ex-Rights Price is an objective measure of the value of company's share after a rights issue and is used as a basis for the calculation of bonus element in Earnings Per Share involving rights issue. TERP simplifies the process of determining the bonus element in EPS calculation since all rights under a rights issue are assumed to be exercised on a single date.
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- How to Calculate TERP
During a rights issue, a company raises capital by offering new shares of its stock to its shareholders. In theory, the shareholders will buy all the new offerings, and this trade will change the price of the company's shares. The theoretical ex-rights price estimates the shares' financial value after the trade, showing shareholders if it is worth exercising their rights to buy new shares or not.
Determine the portion of the company's final shares that exist pre-offering. For instance, if a company moves for a 1-for-4 rights issue: 4 ÷ (1 + 4) = 0.8.
Subtract this answer from 1: 1 - 0.8 = 0.2. This is the portion of the total shares that the issue represents.
Multiply the shares' portion by the share price before the rights issue. For instance, if the shares sell at a price of $2.10: 0.8 × $2.10 = $1.68.
Calculate the price of the newly issued shares. For example, if the company offers them at a 10 percent discount: $2.20 × [(100 - 10) ÷ 100] = $1.98
Multiply this price by the decimal value from Step 2: $1.98 × 0.2 = $0.396
Add together the prices from Steps 3 and 5: $1.68 + $0.396 = $2.08. This is the theoretical ex-rights price.
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