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Theo owns 300 shares of Cratic corp. His basis in the shares is $7,000. He is given by the corporation rights to buy additional shares.

Theo owns 300 shares of Cratic corp. His basis in the shares is $7,000. He is given by the corporation rights to buy additional shares. At the time of the distribution the rights are worth $15,000 and Theo’s shares are worth $200,000.

a) Does Theo have gross income as a result of the distribution and if so how much is it?

b) What is the basis of the rights to Theo?

c) Does the answer to the previous question change, and if so how, if the value of Theo’s stock at the time of the distribution was $60,000?

d) What three things can Theo do with the rights?

e) If the rights expire without any action on Theo’s part what if anything happens to any basis Theo might have in the rights?

NB/ If possible you can do the calculations to answer in that basis. 

Solutions

Expert Solution

A rights issue is an invitation to the existing shareholders to buy additional shares of the company at a discounted price within a specific time frame.

A rights issue is a primary market offer to the existing shareholders to buy additional shares of the company on a pro-rata basis within a specified date at a discounted price than the current market price.

It is important to note that the rights issue offer is an invitation that provides an opportunity for existing shareholders to increase their shareholding. It is a right that a shareholder may or may not choose to exercise and not an obligation to buy the shares.

a.Yes,Theo have gross income as a result of distribution and it is equal to worth of rights issue which is equal to $15000

b.Rights issue are allocated to existing shareholders on the basis of existing shareholding pattren of the shareholders.In this case Theo will be allocated on the basis of 300 shares which he is holding.

c.Right shares are allocated on the basis of number of shares but not on value of shares.Hence our answer will not change even if the value of Theo stock at the time of distribution is $60000

d.Theo will have three options with respect ot rights issue

  1. Exercise the right in full and apply for the eligible rights share.
  2. Exercise the right in full and apply for the eligible rights share as well as additional rights share.
  3. Ignore the rights issue fully and let the rights lapse. No action is required in this case.
  4. Exercise partial rights and let the remaining rights lapse.
  5. Exercise partial rights and transfer the remaining rights to other interested investors. This process of transfer or sale of rights is called renunciation of rights.
  6. Transfer or sell the entire rights issue to other interested investors.

e.If Theo doesn't exercise the rights issue then post the rights issue EPS will be reduced as result of discount factor embedded in rights issue and correspondingly the value of shares will get reduced.

ekkarill92 answered 2 years ago
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