A steel company with 100 crore shares at Rs 120 announces a 1-for-4 rights issue at Rs 80. What is the theoretical ex-rights price, what is each right worth, and what happens to a holder who does nothing?

The theoretical ex-rights price is Rs 112, and each right is worth Rs 32. Rs 12,000 crore of old value plus Rs 2,000 crore of new money, over 125 crore shares, is Rs 112. A holder who takes up or sells the rights stays whole. One who does nothing keeps 100 shares now worth Rs 112 each and loses Rs 8 a share, 6.7% of the holding.

Add the money, then share it out. After the issue the company is worth its old market value plus the cash raised, and that total is divided across the old and new shares. Rs 12,000 crore plus Rs 2,000 crore over 125 crore shares gives Rs 112. The theoretical ex-rights priceThe share price you would expect once a rights issue is done, assuming the market values the new cash at exactly what was paid for it. is theoretical because it assumes the market values the new cash at face value; if investors like the rolling mill, the price can settle higher, and if they do not, lower.

Because shareholders are paying themselves. The Rs 40 discount below the market price is offset exactly by the fall in price from Rs 120 to Rs 112, so a holder who participates neither gains nor loses. It is like a family selling a house to its own members at a discount: the buyers gain what the sellers give up, and when the buyers and sellers are the same people, nothing changes. The right is worth the gap between what a new share is worth and what it costs: 112 less 80, Rs 32, or Rs 8 for each old share since four old shares carry one right.

Take a holder of 100 shares, worth Rs 12,000 before the issue. If she takes up her 25 rights, she pays Rs 2,000 and ends with 125 shares worth Rs 14,000: net Rs 12,000, unchanged. If she sells the rights at Rs 32 each, she gets Rs 800 and keeps 100 shares worth Rs 11,200: again Rs 12,000. If she does nothing, her shares are worth Rs 11,200 and she has lost Rs 800, the value of rights she let lapse.

State the framework and its limit. Whether lapsed rights are worth anything depends on the issue's rules: in some markets unsubscribed shares are sold and the premium is paid back to the holders who lapsed, in others it is simply lost. In India, rights entitlements have been made tradable on the exchange in recent years; confirm the current rules for any specific issue before telling a client what doing nothing costs. Bankers set the discount deep to make the issue near certain to fill, which is why the rights mechanics, not the discount, decide who pays.