Red Shoe Co. has concluded that additional equity financing will be needed to ex

Question

Red Shoe Co. has concluded that additional equity financing will be needed to expand operations and that the needed funds will be best obtained through a rights offering. It has correctly determined that as a result of the rights offering, the share price will fall from $70 to $63 ($70 is the rights-on price; $63 is the ex-rights price,also known as the when-issued price). The company is seeking $18 million in additional funds with a per-share subscription price equal to $35. How many shares are there currently, before the offering? (Assume that the increment to the market value of the equity equals the gross proceeds from the offering.)

Explanation / Answer

Let x be the no of shares before the offering.

Then, 63 = (70x + 18000000)/(x + 18,000,000/35)

63(x + 18,000,000/35) =70x + 18000000

63x + 32400000 - 18000000 = 70x

14400000 = 7x

x = 2057143 shares

Alternative method:

Price after rights = (35 + 70*N)/(N+1) = 63; 35 + 70N = 63n + 63; 7N = 28

Therefore, N = 4.

No of new shares = 18,000,000/35 = 514285.71

No of old shares = 514285.71*4 = 2,057,143

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