Question

#4

Suppose you own 90,000 shares of common stock in a firm with 4.5 million total shares outstanding. The firm announces a plan to sell an additional 1.8 million shares through a rights offering. The market value of the stock is $35 before the rights offering and the new shares are being offered to existing shareholders at a $5 discount. points eBook Print a. If you exercise your preemptive rights, how many of the new shares can you purchase? 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)) 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)) C-2. If you exercise your preemptive right how many original shares and how many new shares do you have? 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)) 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)) References a. New shares b. million C-1. million Market value Total investment Original shares New shares Investment Sale of rights Total investment million d-1. d-2. million million

Answer 1

Rights issue: A rights issue gives an opportunity to existing shareholders to invest in a new equity offering by the company in the proportion of their existing ownership, i.e. if a shareholder owns 1 % of the company, he can invest upto 1% of the new shares being offered under rights issue. The rights issue is made to give an option to existing shareholders to invest further and maintain their current % ownership in the business before offering shares to new shareholders which can dilute their shareholding. - Current % ownership in the company=90,000/4,500,000 = 2% - Issue price in rights issue= Current market price-discount= $35-$5= $30 per share - Current market value= Current shares outstanding*current price per share= 4.5*35= $157.5 million - Proceeds from rights issue= No. of shares being issued*issue price= 1.8*30= $54 million C-1. Particulars Unit Value Formula Explanation of calculation a. New shares | No. 36,000.0 (1,800,000*2%) No. of shares being offered in rights issue* Current % ownership in the company Market Value per share $ (Current market value + Proceeds from rights issue]/(Current shares 33.57 (211.5)/(4.5+1.8) post rights offering outstanding+No. of shares issued in rights issue) Market Value of company $ million 211.5 (157.5+ 54) [Current market value + Proceeds from rights issue] post rights issue [(Current shares held+New shares purchased in rights issue) *price per share Total investment $ million 4.23 [(90,000+36,000)*33.6]/1,000,000 after rights issue]/million Original Shares No. 90,000 Given in question c-2. New shares No. 36,000 As calculated in part 'a' d-1. Investment $ million 3.021 ((90,000)*33.57]/1,000,000 [(Current shares held) *price per share after rights issue]/million Sale of rights $ million 0.180 (36000*5)/1,000,000 (No. of shares entitled to purchase in rights issue* discount per share) million d-2. Total investment $ million 3.201 (3.021+0.180) (Investment as calculated in part 'd-1' + Sale of rights) i Note for part 'b': "Market value of the stock" as required in part 'b' is given as a 'per share' value in the question ($35 per share). So, it may prima facie seems that the question requires market value per share post rights offering. However, since the question has asked values in millions and rounded off to 2 decimals, we must show market value of company post rights issue as has been done above.