Question

Todd Winningham IV 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 Todd 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?

b. If Todd 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.)

c. If Todd 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?

d. If Todd 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?

e. If Todd 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?

Answer 1

Solution :-

(a)

Value of Rights = ( Ex Right Price - Cash For 1 Share ) / Number of Rights

= ( 70 - 50 ) / 5 = $4 per right

Number of Rights = Value of Investment / Value of Right

= $4100 / 4 = 1,025 Rights

Number of Shares = Value of Investment / Value Per Share

= 4100 / 70 = 58.57 shares

(B)

Value of Rights = ( Ex Rights S.P - Cash for 1 Share ) / Number of Rights

= ( 75 - 50 ) / 5 = $5 per right

Dollar Profit on Rights = Number of Rights * ( Profit Per Right ) = 1025 * ( 5 - 4 ) = 1,025

(C)

Dollar Profit on Shares = Shares * ( Profit Per Share )

= 58.57 * ( 75 - 70 ) = 290.86

(D)

Value of Rights = ( Ex Rights Selling Price - Cash For 1 New Share ) / Number of Rights

= ( 42 - 50 ) / 5 = -1.60 or 0

Since value of Right is 0, Todd would lose all the money.

Total Loss = - $4,100

(E)

Dollar Loss on Shares = Shares * ( Profit Per Share )

= 58.57 * ( 42 - 70 ) = -1,640

Total Loss would be 1,640 on 58.57 Shares

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