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In: Finance

Larry holds 2,000 shares of common stock in a company that only has 20,000 shares outstanding....

Larry holds 2,000 shares of common stock in a company that only has 20,000 shares
outstanding. The company’s stock currently is valued at $48.00 per share. The company needs
to raise new capital to invest in production. The company is looking to issue 5,000 new shares
at a price of $38.40 per share. Larry worries about the value of his investment.

1. Larry’s current investment in the company is ?.
2. If the company issues new shares and Larry makes no additional purchase, Larry’s
investment will be worth ?.
3. This scenario is an example of ?
4. Larry could be protected if the firm’s corporate charter includes a ?.
provision.
5. If Larry exercises the provisions in the corporate charter to protect his stake, his investment
value in the firm will become ?.

Solutions

Expert Solution

1) Larry's current investment in the company is 2,000 shares in the company that had 20,000 shares outstanding.and the current price per share is $48

Hence, Larry’s current investment in the company is 2000*48 = $96,000

2) If the company issues new shares and Larry makes no additional purchase then

New value of the company = (No. of shares earlier * market price per share) + ( New issue of shares * New issue price)

=(20000*48 + 5000*38.40) = $1,152,000

Total number of shares after the additional issue = 20000+5000 = 25000

Share price after the issue = Total market value/ total number of shares = 1,152,000/25000 = $46.08

Larry's investment after the company's additional issue = 2000*46.08 = $92160

3) This scenario is an example of the dilution of the shareholder's ownership percentage in the company since the number of shares remains the same for the shareholder after the new capital issue.

4) Pre-emptive offer provision

This provision gives the owner (Larry in this case), the first right to purchase the additional shares. The discretion to purchase or not is with him. If he declines to buy these shares, only after this, the additional shares can be offered to the public.

5) If Larry exercises the provisions in the corporate charter to protect his stake, his investment
value in the firm will become:

Value of Larry's investment prior to the additional capital issue = $96000

Ownership of Larry prior to the additional capital issue = 2000/20000 = 10%

No. of additional shares for Larry = 10% * 5000 = 500 shares

Value of the new shares = 500 * $38.40 = $19200

Total value of Larry's investment if he exercises the provisions in the corporate charter to protect his stake = 96000+19200 = $115,200

jeff jeffy answered 2 years ago
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