Question

Suppose you own 50,000 shares of common stock in a firm with 2.5 million total shares outstanding. The firm announces a plan to sell an additional 1 million shares through a rights offering. The market value of the stock is $35 before the rights offering and the new shares are being offered to existing shareholders at a $5 discount. (LG 8-3)

    If you exercise your preemptive rights, how many of the new shares can you purchase?

    What is the market value of the stock after the rights offering?

    What is your total investment in the firm after the rights offering? How is your investment split between original shares and new shares?

    If you decide not to exercise your preemptive rights, what is your investment in the firm after the rights offering? How is this split between old shares and rights?

Answer 1

a)

Right shares will be generally offered in the proportion of your holding.

Proportion of our shareholding= 50,000/2,500,000=0.02 i.e 2%

No. of shares offered under rights issue= 1 Million

No.of shares that can be subscribed by us = 1 Million *2% = 20,000 shares

b)

Theoretical Ex-rights value of the Firm= Market value immediately before rights issue+ Proceeds from Rights issue = 2.5 Million shares* $35/share + 1 Million shares* $30/Share = $117.5 Million

Theoretical Ex-rights price= (market value immediately before rights issue + proceeds from right issue)/total no of shares after rights issue

= $117.5 Million/3.5 Million= $33.57/ Share

Value of right= $33.57/Share - $30/Share= $3.57/Share

c)

Particulars	No.of Shares	Per Share	Value
Before Rights issue	50,000	$35	1,750.000
Rights issue	20,000	$30	600,000
After Rights issue	70,000	$33.57	2,350,000

d)

Particulars	No.of Shares	Per Share	Value
Before Rights issue	50,000	$35	1,750.000
Loss for not subscribing to Rights issue	20,000	$(3.57)	(71,500)
After Rights issue	50,000	$33.57	1,678,500