Theo owns 300 shares of Cratic corp. His basis in the shares is $7,000. He is...

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?

. 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?19. What three things can Theo do with the rights?

. If the rights expire without any action on Theo’s part what if anything happensto any basis Theo might have in the rights?

Expert Solution

Rights issue:A rights issue is an invitation to existing shareholders to purchase additional new shares in the company. This type of issue gives existing shareholders securities called rights. With the rights, the shareholder can purchase new shares at a discount to the market price on a stated future date. The company is giving shareholders a chance to increase their exposure to the stock at a discount price.

Until the date at which the new shares can be purchased, shareholders may trade the rights on the market the same way that they would trade ordinary shares. The rights issued to a shareholder have value, thus compensating current shareholders for the future dilution of their existing shares' value. Dilution occurs because a rights offering spreads a company’s net profit over a larger number of shares. Thus, the company’s earnings per share, or EPS, decreases as the allocated earnings result in share dilution.

a.Therefore Theo have the gross income as a result of distribution of the right issue i.e 15000$

b.Rights issue will be allocated among the existing shareholders on the basis of the number of shares they hold in the company. In the given case Theo will be allocated to rights issue w.r.t 300 shares he hold in that company.

c.Therefore my answer/rights allocation will not be changed even if value of the stock is 60000$( rights are allocated on basis of number of shares)

d.Theo will have three options with a rights issue. You can (1) subscribe to the rights issue in full, (2) ignore your rights, or (3) sell the rights to someone else. Below we explore each option and the possible outcomes.

e.If Theo dont the benefit of rights issue i.e ignorning the rights issue then post rights issue EPS will be reduced as the result of discount factor which is embedded in such rights issue, thereby value of the shares will get reduced accordingly.

jeff jeffy answered 1 year ago

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