Question

Fred has $4,100 to invest. He has been looking at Gallagher Tennis Clubs Inc. common stock. Gallagher has issued a rights offering to its common stockholders. Five rights plus $50 cash will buy one new share. Gallagher’s stock is selling for $70 ex-rights.

a-1. How many rights could Fred buy with his $4,100? (Do not round intermediate calculations and round your answer to the nearest whole number.)
  

a-2. Alternatively, how many shares of stock could he buy with the same $4,100 at $70 per share? (Do not round intermediate calculations and round your answer to the nearest whole number.)
  

b. If Fred invests his $4,100 in Gallagher rights and the price of Gallagher stock rises to $75 per share ex-rights, what would his dollar profit on the rights be? (First compute profit per right.) (Do not round intermediate calculations and round your answer to the nearest whole dollar.)
  

c. If Fred invests his $4,100 in Gallagher stock and the price of the stock rises to $75 per share ex-rights, what would his total dollar profit be? (Use the rounded number of shares from part a-2. Do not round any other intermediate calculations and round your answer to the nearest whole dollar.)
  

d. If Fred invests his $4,100 in Gallagher rights and the price of Gallagher’s stock falls to $42 per share, ex-rights, what would his dollar profit on the rights be? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to the nearest whole dollar.)
  

e. If Fred invests his $4,100 in Gallagher stock and the price of Gallagher’s stock falls to $42 per share ex-rights, what would be his total dollar profit? (Negative amount should be indicated by a minus sign. Use the rounded number of shares from part a-2. Do not round any other intermediate calculations and round your answer to the nearest whole dollar.)
  

Answer 1

Solution:
a.1:
say R is the price of a single right issued.
it is given that : Five rights plus $50 cash will buy one new share.
Putting this in an equation
5R + $50 = $70
From above equation, R = $4. i.e., a sincle right value comes to $4, four dollars.
Fred can buy a total of $4,100/$4 = 1025 rights.
a-2.
With $4,100 and at $70 per share, Fred can buy $4,100/$70 = 58.5714
i.e., Fred can buy 58 shares of stock, at $70 per share.
b.
Fred invests his $4,100 in Gallagher rights and the price of Gallagher stock rises to $75 per share ex-rights.
Total number of rights with Fred = 1025 (calculated in a.1).
Each Share is selling at $70 ex-rights.
If share prise rises to $75 per share ex-rights, profit per share = $5.
With every one right , Fred can exercise his right to buy share at $70 and sell in market at $75, per share , Fred can make dollar profit of $5 per right.
Total dollar profit on rights = ($5*1025) - $4,100 = $5,125 - $4,100 = $1,025
c.
Fred invests his $4,100 in Gallagher stock and the price of the stock rises to $75 per share ex-rights.
Total number of shares with Fred = 58 (calculated in a.2).
Each Share is selling at $70 ex-rights.
If share prise rises to $75 per share ex-rights, profit per share = $5.
Fred can sell in market at $75 per share , Fred can make dollar profit of $5 per share.
Total dollar profit = ($5*58)   = $290
d.
Fred invests his $4,100 in Gallagher rights and the price of Gallagher’s stock falls to $42 per share, ex-rights.
Total number of rights with Fred = 1025 (calculated in a.1).
Each Share was selling at $70 ex-rights at issue.
If share prise falls to $42 per share ex-rights , Fred can make dollar profit of -$28 per right.
Profit per share = $42 - $70 = - $28.
Total dollar profit on rights = (-$28*1025) - $4,100 = - $28,700 - $4,100 = -$32,800
e.
Fred invests his $4,100 in Gallagher stock and the price of Gallagher’s stock falls to $42 per share ex-rights.
Total number of shares with Fred = 58 (calculated in a.2).
Each Share is selling at $70 ex-rights at issue.
If share prise falls to $42 per share ex-rights, profit per share = $42 - $70 = -$28.
Total dollar profit = -$28*58   = - $1624