Question

Suppose you own 88,000 shares of common stock in a firm with 4.4 million total shares outstanding. The firm announces a plan to sell an additional 2.2 million shares through a rights offering. The market value of the stock is $40 before the rights offering and the new shares are being offered to existing shareholders at a $5 discount.

a.	If you exercise your preemptive rights, how many of the new shares can you purchase?

  

New shares

b.	What is the market value of the stock after the rights offering? (Enter your answer in millions rounded to 1 decimal place. (e.g., 32.1))

  

Market value

$ million

   

c-1.	What is your total investment in the firm after the rights offering? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places. (e.g., 32.16))

  

Total investment

$ million

c-2.	If you exercise your preemptive right how many original shares and how many new shares do you have?

Original shares
New shares

d-1.	If you decide not to exercise your preemptive rights, what is your investment in the firm after the rights offering? (Do not round intermediate calculations. Enter your answer in millions rounded to 3 decimal places. (e.g., 32.161))

Investment

$ million

d-2.	If you sell your rights rather than use them, how much money will you receive from the rights sale and what is the total value of your proceeds from the sale of the rights offering plus your investment in the firm? (Enter your answer in millions rounded to 3 decimal places. (e.g., 32.161))

Sale of rights	$ million
Total investment	$ million

Answer 1

(a) Number of Shares owned by Investor = 88000, Total Number of Shares Outstanding = 4.4 million or 4400000

Proportion of Shares owned by Investor = (88000 / 4400000) = 0.02 or 2 %

Number of Shares Offered under Rights Issue = 2.2 million or 2200000

Current Share Price = $ 40

Share Price under Rights Offering = $5 discount to current price = (40-5) = $ 35

If the investor exercises his/her preemptive rights, then he/she can purchase the same proportion of the total rights offering as the proportion of shares held by him/her at present.

Therefore, the Number of Shares Purchasable under Rights Offering = 2 % of Rights Offering = 0.02 x 2200000 = 44000

(b) Value of Stocks offered under the Rights Issue = N1 = 2200000 x 35 = $ 77000000 and Value of Stocks Existing = N2 = 40 x 4400000 = $ 176000000

New Price per Share post Rights Offering = (N1 + N2) / Total Number of Shares Outstanding = (77000000 + 176000000) / (4400000 + 2200000) = $ 38.33

Market Value of Shares Post Rights Offering = 38.33 x (4400000 + 2200000) = $ 252978000 or $ 252.978 million ~ $ 253 million

(c1) Total Investment in Firm post Rights Offering = Initial Investment + Investment as part of RIghts Offering = 40 x 88000 + 35 x 44000 = $ 5060000 or $ 5.06 million

(c2) If preemptive rights are exercised, then Number of Original Shares = 88000 and Number of New Shares = 44000

(d1) Price per Share post Rights Offering = $ 38.33

Number of Shares Originally Held = 88000

Value of Investment post Rights Issue = 88000 x 38.33 = $ 3373040 or $ 3.373 million

(d2) Assuming that one rights can be used to purchase one share, we have price per rights = Discount Per Share / (Number of Rights Required to buy One Share + 1) = 5 / (1+1) = $ 2.5

Sale of Rights Value = Price per Rights x Number of Shares Offered under Rights Issue = 2.5 x 44000 = $ 110000

Total Investment = Existing Investment Value Post Rights Issue + Sale of Rights = 3373040 + 110000 = $ 3483040 or $ 3.483 million