The management of Dragonfly Inc. has decided to increase its equity capital by undertaking a rights...

The management of Dragonfly Inc. has decided to increase its equity capital by undertaking a rights issue. It is planned to raise additional capital of $20 million. The company has 5,000,000 outstanding common shares with a current market price of $50 per share. Shareholders need 10 rights to buy a new share.

a) Calculate the ex-rights price per share and the value of a right.

b) Justin currently has 20,000 shares of Dragonfly’s common stock and $50,000 cash. Assume Justin exercises his rights to buy the new shares, determine the amount of gain or loss for Justin.

Expert Solution

	Number of rights shares to be issued = 5000000/10 =	500000
	Price per rights share = 20000000/500000 =	$ 40.00
a)	Ex-rights price per share = (5000000*50+20000000)/(5500000)=	$ 49.09
	Value of a right = 50-49.09 =	$ 0.91
b)	Justin's total wealth before exercising the right:
	Value of 20000 shares = 20000*50 =	1000000
	Cash	50000
	Total wealth before exercising the right	1050000
	Justin's total wealth after exercising the right:
	Value of (20000+50000/40)*49.09 shares	1043163
	Total wealth before exercising the right	1050000
	Loss	6837
	Loss arises because, Justin is taking only 1250 right shares
	(5000040) against the 2000 right shares (2000010%) that
	he is entitled. If he had taken the entire 2000 rights shares
	he would have ended up with the same wealth as before.

jeff jeffy answered 2 years ago

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