Question

The Clifford Corporation has announced a rights offer to raise $20 million for a new journal, the Journal of Financial Excess. This journal will review potential articles after the author pays a nonrefundable reviewing fee of $4,000 per page. The stock currently sells for $40 per share, and there are 1.5 million shares outstanding.

a.	What is the maximum possible subscription price? What is the minimum? (Leave no cells blank - be certain to enter "0" wherever required.)
b.	If the subscription price is set at $32 per share, how many shares must be sold? How many rights will it take to buy one share? (Do not round intermediate calculations. Round your rights needed answer to 2 decimal places, e.g., 32.16.)
c.	What is the ex-rights price? What is the value of a right? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
d.	A shareholder with 1,000 shares before the offering has no desire (or money) to buy additional shares offered as rights. What is his portfolio value before and after the rights offer? (Do not round intermediate calculations and round your answers to nearest whole number, e.g., 32.)

Answer 1

Part a:
The maximum possible subscription price will be equal to market price of the stock. So, maximum possible subscription price=$40. Minimum possible subscription price would be an amount be greater than zero as stock prices cannot be negative and stock price of $0 is meaningless.

Part b:
The number of shares = Amount to raise/Subscription price
Given that, Clifford Corporation has announced a rights offer to raise $20 million. So, amount to raise=$20*1000000=$20000000
Subscription price=$32 per share
The number of shares that must be sold=$20000000/$32=625000

To calculate the number of rights it will take to buy one share we need to use the following formula:

Number of rights it will take to buy one share=(Number of shares outstanding)/(Number of new shares to be issued)

Given that, there are 1.5 million shares outstanding.  
Number of new shares to be issued=625000
Number of rights it will take to buy one share=1.5*1000000/625000=2.4

Part c:
First we need to calculate the value of a right. Before the ex-date (or ex dividend date) we can calculate the value of a right using the formula below:
(Market price-Subscription price)/(Number of rights required to buy one share + 1)
Market price=$40
Subscription price=$32
Number of rights required to buy one share=2.4
Value of a right=($40-$32)/(2.4+1)=$8/3.4=$2.352941176 or $2.35 (rounded upto two decimal places)

Generally, on the ex dividend date, the stock price decreases by an amount equal to the right amount.
So, we will have $40 - $2.35 = $37.65 (This is the new market price)

Ex-right price=(New market price-Subscription price)/Number of rights to buy a share
New market price=$37.65
Subscription price=$32
Number of rights to buy a share=2.4
Substituting the values in the equation, we get:
Ex-rights price=($37.65 - $32) / 2.4 = $2.35

Part d:
Portfolio value before ex-rights=Number of shares owned*Market price per share=$40*1,000 = $40,000

Portfolio value after ex-rights=Number of shares owned*Ex-rights price of the stock=$37.65*1,000 = $37,650