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.

Solutions

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 1 year ago

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