Professional Documents
Culture Documents
TABLE OF CONTENTS
INTRODUCTION ....................................................................................................................................... 3 CAPITAL BUDGETING .......................................................................................................................... 3 IMPORTANCE OF CAPITAL BUDGETING .......................................................................................... 3 THE CAPITAL BUDGETING PROCESS ................................................................................................ 3 BASIC PRINCIPLES OF CAPITAL BUDGETING ................................................................................... 4 A FEW BASIC CONCEPTS IN CAPITAL BUDGETING .............................................................................. 4 SUNK COST ...................................................................................................................................... 4 OPPORTUNITY COST........................................................................................................................ 4 CANNIBALIZATION .......................................................................................................................... 5 INCREMENTAL CASH FLOWS ........................................................................................................... 5 PROJECT VALUATION METHODS: ....................................................................................................... 6 NET PRESENT VALUE (NPV) ............................................................................................................. 6 INTERNAL RATE OF RETURN (1RR) .................................................................................................. 7 COMPARISON BETWEEN NPV AND IRR........................................................................................... 7 PAYBACK PERIOD ............................................................................................................................ 8 PROFITABILITY INDEX ...................................................................................................................... 9 AVERAGE ACCOUNTING RATE OF RETURN (AAR) ......................................................................... 10 WHY MERGERS & ACQUISITIONS? .................................................................................................... 11 M&A DEFINITIONS ............................................................................................................................ 12 METHODS OF VALUATION ................................................................................................................ 12 REPLACEMENT COST ..................................................................................................................... 12 MARKET PRICE .............................................................................................................................. 12 BOOK VALUE ................................................................................................................................. 12 CASH FLOW BASED........................................................................................................................ 13 MULTIPLES BASED ......................................................................................................................... 13 MEASURING CASH FLOWS ................................................................................................................ 14 FCFF/FCFE, DIVIDEND, RESIDUAL INCOME ................................................................................... 14 DISCOUNT RATE ................................................................................................................................ 16 MODIGLIANI MILLER THEOREMS .................................................................................................. 16 WEIGHTED AVERAGE COST OF CAPITAL ....................................................................................... 17 COST OF DEBT ............................................................................................................................... 17
Step Three: Planning the Capital Budget- Next, the profitable proposals are organized after taking into account two key considerations: o The match between the proposal and the companys overall strategic objectives, o The projects timing. Since companies have various financial and other resource constraints, the proposals usually have to be scheduled on a priority-basis. Step Four: Monitoring and Post-auditing- Post-auditing capital projects are as important as selecting and implementing them. Firstly, it serves to monitor the analysis and forecasts that the capital budgeting process is based on. Overly optimistic forecasts can be detected and such systematic errors rectified. Secondly, the negative deviation between actual performance and expectations can be corrected by taking adequate measures, wherever possible, which in turn improves business operations. Lastly, sound ideas for future investments may be evolved during post-auditing current investments.
PRINCIPLE: Todays decisions should be based on current and future cash flows and should not be affected by prior or sunk costs. OPPORTUNITY COST An opportunity cost is the worth of the next-best alternative that has been forgone in order to pursue the current course of action. In capital budgeting, the opportunity cost of capital or the discount rate is the expected rate of return that is foregone by investing in the project chosen rather than investing in the nextbest alternative. EXAMPLES: Suppose that a company already owns a building that could be used for a new project instead of buying a new building. If the companys managers decide to use this building, the company would not incur the cash outlay of $12 million that would be required to buy a new building. Would this mean that the $12 million expenditure should be excluded from the analysis, which would obviously raise the expected NPV? The answer is that we should exclude the cash flows related to the new building, but we should include the opportunity cost associated with the new building as a cash cost.
PRINCIPLE: The opportunity cost of capital for an investment project is the expected rate of return demanded by investors in common stocks or other securities subject to comparable risks as the project. CANNIBALIZATION Cannibalization takes place when an investment results in one part of a company taking away customers and sales from another part. An externality is defined as the effect that an investment has on other things besides the investment itself and cannibalization is one such externality. The lost cash flows due to cannibalization should be charged to the new project. However, it often turns out that if the company would not have produced the new product, some other company would have and hence, the old cash flows would have been lost anyway. In this case, no charge should be assessed against the new project. All this makes determining the cannibalization effect difficult, because it requires estimates of changes in sales and costs, and also of the timing when those changes will occur. EXAMPLE: Apples introduction of the iPod nano caused some people who were planning to purchase a regular iPod to switch to a nano. The nano project generates positive cash flows, but it also reduces some of the companys current cash flows. This is a manifestation of the cannibalization effect because the new business eats into the companys existing business.
PRINCIPLE: Cannibalization can be important, so its potential effects should be considered and any significant lost cash flows due to it should be charged to the new project. INCREMENTAL CASH FLOWS An incremental cash flow is a cash flow that is the result of a specific decision made: the cash flow with a decision minus the cash flow without that decision. If opportunity costs are correctly assessed, the incremental cash flows provide a sound basis for capital budgeting. (Corporate Finance and Portfolio Management) Most managers naturally hesitate to throw good money after bad. For instance, they are reluctant to invest more money in a losing division. But occasionally turnaround opportunities can be encountered in which the incremental NPV on investment in a losing division is strongly positive EXAMPLE: Suppose that a railroad bridge is in urgent need of repair. With the bridge the railroad can continue to operate; without the bridge it cannot. In this case, the payoff from the repair work consists of all the benefits of operating the railroad. The incremental NPV of such an investment may be enormous.
PRINCIPLE: The value of a project depends on all the additional/incremental cash flows that follow from project acceptance and hence, incremental cash flows provide a sound basis for capital budgeting. PROJECT VALUATION METHODS: The most comprehensive and often used measures of whether a project is profitable or unprofitable are the net present value (NPV) and internal rate of return (IRR). NET PRESENT VALUE (NPV) For a project with a single initial investment outlay, the net present value (NPV) is the present value of the future after-tax cash flows discounted at the relevant discount rate minus the investment outlay, or
where Ct = the net cash receipt at the end of year t Io = the initial investment outlay r = the discount rate/the required minimum rate of return on the investment n = the project/investment's duration in years. EXAMPLE: Suppose a company is considering an investment of $70 million in a capital project that will return after-tax cash flows of $20 million per year for the next three years plus another $30 million in year 4. The required rate of return is 10 percent. Here, the NPV would be NPV= 20/1.1 + 20/1.1^2 +20/1.1^3 + 30/1.1^4 70 = 70.2274 70 = $0.2274 million. Thus the investors wealth is expected to increase by a net of $0.2274 million. This indicates the decision rule for NPV: Invest if Do not invest if NPV > 0 NPV < 0
Positive NPV investments increase investor wealth whereas negative NPV investments decrease it. Many investments have cash outflows that occur not only at time zero, but also at future dates. In this case, all cash outflows are taken as negative and discounted at the required rate of return just as in the case of positive cash inflows at different points of time.
Where CF = the cash flow generated in the specific period (the last period being n) r = the IRR In the above example given for NPV, the IRR is the discount rate that solves the following equation: -70 + 20/(1+IRR) + 20/(1+IRR)^2 + 20/(1+IRR)^3 + 30/(1+IRR)^4 =0 Algebraically, this equation would be very difficult to solve. Normally, trial and error method is resorted to, systematically plugging various discount rates until one, the IRR, satisfies the equation. But financial calculators and spreadsheet software have routines that calculate IRR easily, so the trial and error method can be avoided. The IRR is 10.14 percent here. The decision rule for the IRR is to invest if the IRR exceeds the required rate of return for a project: Invest if Do not invest if IRR > r IRR < r
In the above example, since the IRR of 10.14 percent exceeds the projects required rate of return of 10 percent, the company should invest. COMPARISON BETWEEN NPV AND IRR NPV is a theoretically sound method that provides a direct measure of the expected increase in firm value. Its main drawback is that it does not take the size of the project into consideration. IRR provides information about how much below the IRR (estimated return) the actual project return could fall, in percentage terms, before the project becomes uneconomic (has a negative NPV) (Corporate Finance, Portfolio Management, and Equity Investments). Thus, the IRR reflects the margin of safety that the NPV does not. Project Ranking conflicts- In the case of two mutually exclusive projects, the decision rules for NPV and IRR, as applied, might give conflicting decisions. For instance, for two mutually exclusive projects A and B, project A might have a larger NPV than Project B whereas Project B has a higher IRR than Project A. Differing patterns of future cash flows and dissimilar project sizes are some of the causes of this situation. The thumb rule here is to always choose the project based on NPV. Multiple IRR Problem- For projects with cash outflows not only at time zero, but also at other points during its life or at the end of its life (projects with unconventional cash flows), there may be more than one IRR.
Year 1 2 3 4 5 6 7 8
Investment $4,000
2,000
What is the payback period on this investment? The answer is 5.5 years, but to obtain this figure it is necessary to track the unrecovered investment year by year. The steps involved in this process are shown below:
1 2 3 4 5 6 7 8
$4,000
$1,000 0 2,000
By the middle of the sixth year, sufficient cash inflows will have been realized to recover the entire investment of $6,000 ($4,000 + $2,000). (Accounting for Management) The drawbacks of the payback period are apparent. Since the cash flows are not discounted at the projects required rate of return, the payback period ignores the time value of money and the risk of the project. Additionally, the payback period ignores cash flows after the payback period is reached. Thus this method provides a good measure of payback and not of profitability. But its simplicity and easy calculation make it useful as an indicator of project liquidity. Thus a project with a two-year payback may be more liquid than a project with a longer payback. The discounted payback period partially addresses the shortcomings in the payback period method. It takes the cumulative discounted cash flows from the project into consideration while calculating the number of years it takes to recover the original investment. Thus, it takes the time value of money and risk of the project into account, but this method also ignores the cash flows that occur after the discounted payback period is reached. For a project with negative NPV, there will not be any discounted payback period since it never recovers its original investment. The discounted payback period must be greater than the payback period without discounting. PROFITABILITY INDEX The profitability index (PI) is the present value of a projects future cash flows divided by the initial cash outlay. It can be expressed as PI = PV of future cash flows/ Initial investment = 1 + ( NPV/ Initial investment) Thus, it can be seen that PI is closely related to NPV. The PI is the ratio of the PV of future cash flows to the initial investment, whereas the NPV is the difference between the PV of future cash flows and the initial investment. Whenever the NPV is positive, the PI will be greater than 1; conversely, whenever the NPV is negative, the PI will be less than 1. (Corporate Finance and Portfolio Management)
EXAMPLE: In the example discussed for NPV and IRR above, the company had an outlay of $70 million, a present value of future cash flows of $70.2274 million, and an NPV of $0.2274 million. The Profitability Index = 70.2274/70 = 1.0032 Because the Profitability Index > 1, this investment is profitable. Thus the PI indicates nothing but the value received when we invest one unit of currency. Although the PI not used as often as the NPV and IRR, it is useful as a guide in capital rationing. AVERAGE ACCOUNTING RATE OF RETURN (AAR) The average accounting rate of return (AAR) can be defined through the following formula: AAR = Average net income/ Average book value EXAMPLE: Suppose a company has an average net income of $20000 each year during a five-year period from an asset. The initial book value of the asset is $250000, depreciating by $50000 per year until the final book value is 0. The average book value for this asset is (250000 0)/2 = 125000. The average accounting rate of return is AAR = 20000/125000 = 16% The advantages of the AAR are that it is simple to compute and understand. But, the AAR suffers from some important conceptual limitations in that it uses accounting concepts like net income instead of cash flows. The time value of money is also ignored. This is no specific rule or cut-off number in ARR that can be applied to distinguish between profitable and unprofitable investments. Thus sound methods like NPV and IRR should be used over ARR, wherever possible.
METHODS OF VALUATION There are several methods for valuation and depending on the industry different methods are the gold-standard when it comes to valuing companies. In this section we will look at some of the most common methods, discuss what is right or wrong about them and in which sector are they used the most. REPLACEMENT COST This is method is used to value the firm by totaling the cost incurred in replacing the assets of the firm today. This method reflects current conditions and is quite effect in valuing firms during periods of high inflation. But this method is not without its share of disadvantages replacement cost is the cost of replacing assets today, but usually managers dont expect the old designs/assets to continue in the future. Besides being subjective, it is also problematic to value intangible assets. Another question to be asked before using this method is, what is being replaced and by what? MARKET PRICE The market value of the firm is simply the sum of market values of debt and equity. Market value of equity can be obtained by multiplying share price with the number of shares whilst the market value of debt can be calculated by using present value of estimated debt cash flows. In some cases book value of debt (from balance sheet) is used as a proxy for market value of debt As the market prices reflect what is known, this method is a logical place to start valuation if the shares are actively traded in the market and the market is efficient i.e. the prices reflect all public information available about the firm. It is therefore a useful metric for merger negotiations. BOOK VALUE Book value of a firm is derived from the books of accounting. It is a simple method for valuing firms with audited financial reports. An advantage is that it reflects the principle of conservatism as accounting relies on the same principle. The failings of this method include inability to value intangible assets, based on past market information. Also, Book value is a backward looking figure, whereas valuation needs to be forward looking.
EV/EBITDA This is the most common enterprise multiple. EBITDA is a measure of pre-interest, pre-tax operating cash flow to both debt and equity holders; hence it makes sense to use Enterprise Value and not Price in the numerator. EBITDA is frequently positive. Enterprise Value (EV) is calculated as sum of market values of common equity, debt, preferred stock minus the cash and short term investments. Short term investments are subtracted as the acquirer must buyout both equity and debt holders and then receives cash. Advantages EV/EBITDA is better than P/E when the levels of financial leverage differ EBITDA includes depreciation and amortization while EPS is post both. Hence for capital intensive business (subject to depreciation) EV/EBITDA is much better. EV/S Enterprise Value-to-Sales is a better alternative to Price-to-Sales ratio because not all sales are attributed to the equity investors. Also in a debt financed company, P/S is not meaningful.
Non-Financial Besides the set of financial ratios discussed above there are certain industry-specific ratios that are non-financial in nature and are useful places to start valuation. Ideally one would want to use nonfinancial ratios to triangulate the valuation rather than using it as a primary measure. o Retail Companies Same stores sales Sales per square meter Service Sectors Revenues per employee Net income per employee Hotel/ Hospitals Average daily rate Occupancy rate Financial Firms Current Account Savings Account Net Interest Margins Monetary reserves
MEASURING CASH FLOWS In an earlier section, we talked about the various methods of valuation and which is the methods to be applied where. In this section we will start from the cash flow methods. A firm in its daily operations will generate cash and we will use the cash so generated to value the firm. FCFF/FCFE, DIVIDEND, RESIDUAL INCOME Cash flow, as the name suggests, concerns the inflows and outflows of cash (liquidity) in a business. While cash flows do not always convey much information about the profitability of the firm, they are of prime importance as they indicate the ability of firm to finance its operating capital needs and the requirements of
Free Cash Flow = EBIT*(1-t) + Depreciation/Amortization Changes in Working Capital Investment in fixed assets This cash flow is also called the Free cash flow to the Firm and is available to all the security holders of the organization including equity and debt holders alike. Since debt holders also have a claim on the cash flow described above, we can further find out cash flow available to equity holders called Free Cash Flow to Equity (FCFE). FCFE additionally takes into consideration repayment of debt as well as new debt capital raised by the firm. It is given by:
FCFE = FCFF + New debt Debt Repayment Preferred Dividends- Interest*(1-t) Example: Following are the details for a firm: Net Income = $2,176 Million, Capital Expenditures = $494 Million, Depreciation = $ 480 Million, Change in Non-Cash Working Capital = $ 35 Million. FCFE = 2176 + 480 494 35 FCFE = $2127 million (Source: Damodaran) Now, that we know what is the surplus cash available to the equity holders, the question arises as to what does firm do with this cash? There are two options for the firm, either to invest further in the business or to pay out the cash to equity holders in the form of dividends. Dividend is basically the portion of earnings of the firm paid out to equity holders. In this context we define payout ratio with the ratio of earnings of the firm distributed to equity holders
Payout ratio = Dividend per share / Earnings per share Example: Consider a firm that has EPS of $2.5 and pays out $0.5 as dividend Then payout ratio = 0.5/2.5 = 0.2 The dividends are of particular interests to shareholders since that is the only way they get paid back for the equity capital invested in the firm (except liquidation). Thus, dividends are instrumental in finding the value of equity shares of a firm as we will see later. So far, we have discussed about the cash flows available to firm and the equity holders. If, however, we wanted get a better idea of the kind of returns shareholders are getting, we use another measure called residual value or Economic Value Added (EVA)
EVA = income earned cost of capital * capital employed The advantage of using EVA is that it does not just look at the earnings of the firm but also takes into consideration the returns on capital required or the cost of the capital. If a firm/division has a positive
Expected return on assets, Where, D is the market value of the Debt, E is the market value of the Equity, and rD and rE are the cost of debt and equity respectively.
WACC = Where, D is the market value of the Debt, E is the market value of the Equity, T is the Tax rate and r D and rE are the cost of debt and equity respectively. Example: Consider a firm for which cost of debt = 8%, cost of equity = 15%, tax rate = 35% & D/E = 9.According the formula, WACC = 0.08*(1-0.35)(0.9)+0.15*0.1 = 0.62 = 6.2% In order to gain a better understanding of WACC, let us explore each of the terms further. COST OF DEBT Cost of debt (rD) is the rate of interest that has to be paid on the debt capital issued by the firm. Usually, it depends on the leverage ratio (D/E) of the firm and the default risk. If the D/E ratio increases, then the probability that creditors will not get fully reimbursed if the firm is dissolved increases which leads to a rise in cost of debt. Thus, the cost of debt can be modeled as a risk free rate plus a risk premium which incorporates the risk of default. Since cost of debt is composed of interest paid, it is fairly easy to calculate. COST OF EQUITY Cost of Equity (rE) is the rate of return demanded by the investors. It is effectively the opportunity cost of investing in the firm for equity holders. Since, creditors have the first claim on the assets of the company; cost of equity is greater than the cost of debt. Estimation of cost of equity presents considerably more challenge compared to the cost of debt. For estimating rE we can use the Capital Asset Pricing Model (CAPM). According to CAPM,
Expected return on stock = rf + (rm rf) Where rf is the risk free rate of return, rm is the expected rate of return on market portfolio and beta is the measure of market risk on the stock i.e how sensitive it is to movements in market. Since, cost of equity is greater than cost of debt, one may wonder if it is possible to reduce overall WACC by taking more and more debt. The answer ofcourse is that it cannot be done and the reason comes from Modigliani Miller theorem. With increase in leverage, the cost of equity rises (since with rising debt, the risk for equity holders increases). Exactly how much does the cost of equity increase can be calculated as follows: The firms asset Beta can be written as
a = D *(D/D+E) + E*(E/D+E) Now, when D/E ratio changes, since ra does not depend on financing decision of the firm (MM), a remains unchanged. Thus, for the original D/E ratio and using original E, calculate the a. This is called unlevering the . Equity for new leverage ratio can then be calculated as
Where FCFi represents Free cash flow to firm in period i, and H is the horizon. PVH is the expected value of firm after period H, the horizon chosen for valuation. Valuation horizons are used because it would be impractical and error prone to try and calculate cash flows till infinity. PVH is effectively an estimate of discounted cash flows from year H+1 onwards. It can be calculated in many ways, some of which are constant growth method, based on P/E ratio etc. DDM: Another method for valuing a firm would be to calculate the value of equity and then add the value of debt. To calculate the value of Equity, we need the price of a share. Let us see how it can be calculated. We know that price of any project/investment is equal to the discounted cash flows in future years. For an equity
P0 = DIV1/(r-g) And why do the dividends grow? Because the firms do not pay out all of the earnings as dividends. Some of the earnings are reinvested into the business and earn incremental income leading to growth in dividends as well. Recall, that the ratio of earnings paid out as dividends is called the payout ratio = DIV/EPS (where EPS is earnings per share). Thus, 1- DIV/EPS represents the fraction of income reinvested in the business. This is called the plowback ratio. The ploughed back capital would earn a return equal to the Return on Equity earned by the company and thus if the payout ratio stays constant, the income and hence the dividend would grow at g = plowback ratio * ROE. A major assumption that we have made in the above discussion is that all these ratios remain constant which is rarely the case in real life scenarios. For stocks with variable growth rates we find dividends for each year separately and then sum the discounted value to get the price of stock. The process is similar to that in DCF.
Where DIVi represents dividend in ith period and PH is the expected price of stock at the end of period H. Usually H is chosen to be the time when the firms growth is expected to stabilise. Example: Consider a firm that has an EPS of Rs. 10 and a payout ratio of 0.5. Furthermore, the ROE is 15%, and discount rate is 10%Then, g = 0.5*0.15 = 0.075;P = Price of share = 10*0.5/(.1-0.075) = Rs. 200 FINANCING THE PECKING ORDER THEORY OF FINANCE As per the Pecking Order Theory of Finance, a firm prefers to utilize internal sources of funding i.e. retained earnings over external sources of funding. Further, in the latter case, a firm would prefer to issue debt over equity. The theory is based on the idea that information asymmetry between a firms managers and shareholders and transaction costs incurred in raising funds from external sources influence the firms choice of capital structure. Consider a firm which needs funds for a project. It can raise debt or equity or use internal accruals. If the firms prospects are more positive as compared to its current market valuation, it would prefer to issue debt rather than issuing equity as it is undervalued. On the contrary, another firm which has poorer prospects vis-vis its current market valuation would prefer to issue equity over debt to avoid worsening its financial position. However, there is information asymmetry between investors who are external to the firm and the managers who run the business. Consequently, investors tend to draw inferences from the actions of the managers. Rational investors would conclude that an equity issuing firm has an overvalued share price and debt issuing firms have an undervalued one. Hence, the share price of an equity issuing firm would fall. To avoid this fate,
Priority 1 a b c d 2 3
Instrument Debt Senior Secured Debt Senior Unsecured Debt Subordinated Debt Mezzanine Debt Preferred Stock Ordinary Shares
EQUITY: TRANCHES AND SENIORITY There are two main types of equity: preferred stock and common stock. Preferred stocks or preference shares are senior to common stocks as they have preference over common stocks in dividend payouts arising from liquidation or distribution of earnings. A preferred stock usually carries no voting rights and may have no fixed maturity. If a preference share has no fixed maturity, it is a called a perpetual preference share. Due to their fixed dividend, a preference share usually holds less possibility for appreciation as compared to a common stock. Depending on whether the dividend payable on a preferred stock is deferrable or not they are classified as cumulative and non-cumulative. Depending on whether a prefer stock is callable or not they are classified as redeemable or irredeemable preference shares. If the preferred stock is convertible into equity, it is called a convertible preferred stock. Unlike common stocks preferred stocks have no voting rights. Common stocks Common stocks or ordinary shares are the least secured claims in the capital structure of a company. They are ranked lower to all types of debt and preferred stock and form the residual claim on a companys assets during liquidation. Consequently, equity holders are the last to be paid off during distribution of profits. Common stocks usually carry voting rights. These rights enable shareholders to vote at meetings, nominate directors and decide the corporate policy of the company. However, unlike preferred stock, there is no fixed dividend payable to common stock holders which makes their returns volatile. A major attraction of common stocks is the potential for capital appreciation which they offer. Common stocks are perpetual in nature and extinguish only on liquidation of the company. IPO INITIAL PUBLIC OFFERING When a company offers its shares for subscription to the public for the first time, the offering is called an Initial Public Offering. An IPO could be dilutive or non-dilutive or a mix of the two. In a dilutive offering, fresh shares are issued to new subscribers which dilute the EPS and shareholding for the existing shareholders. In non-dilutive offering existing shareholders sell some or all of their shares as part of the offering thereby keeping total number of shares & EPS constant. An IPO involves taking a private company public. Reasons for undertaking an IPO include lower cost of capital, greater liquidity for shareholders, opening up newer sources of funding, greater prestige related to being a public company, raising funds without reducing control (loss of Board seats). An IPO is undertaken through underwriters who form a syndicate to sell the issue to the public. The underwriters also buy the non-subscribed portion of shares in case actual subscription is below expectations. The pricing of an IPO is a contentious issue for both the company and investors. An underpriced issue could lead to oversubscription but will also imply that the company has left too much money on the table. An overpriced issue would lead to under subscription and could lead to losses on listing to investors which is also not desirable. Some of the recent oversubscribed IPOs include Coal India, MOIL, Punjab & Sind Bank Ltd. The IPO of A2Z Maintenance was under-subscribed 0.33 times.
Appointment of I-bankers & Registrars Actual Listing Submission of Draft Offer Prospectus
Step 1
FPO- FOLLOW-ON PUBLIC OFFER Any public issue of shares by a company subsequent to an IPO is called a follow-on public offer (FPO). NTPC and NMDC came out with FPOs recently. SEO-SEASONED EQUITY OFFERING A Seasoned Equity Offering is a FPO by an established company whose shares have substantial liquidity and trading volume in the secondary markets A seasoned equity offering could be either dilutive or non-dilutive. RIGHTS ISSUE A rights issue is an invitation to the existing shareholders to buy more shares of the company. The number of shares offered in a rights issue is in a fixed proportion to their current holdings. The rights are similar to a call option as they vest in the rights owner the right to buy a specified number of shares at a pre-specified price on a stated maturity date. The rights holder can exercise the rights, allow them to lapse or sell them to other investors. The intrinsic value of the rights helps to compensate the shareholder for the subsequent dilution. However, if the rights are Non-renounceable they will not be tradable.