Suppose you own 40,000 shares of common stock in a firm with 2 million total sha

Question

Suppose you own 40,000 shares of common stock in a firm with 2 million total shares outstanding. The firm announces a plan to sell an additional 0.6 million shares through a rights offering. The market value of the stock is $34 before the rights offering and the new shares are being offered to existing shareholders at a $4 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))

Explanation / Answer

(a)

New Shares =( No. of share held/ total no. of shares in common stock) * no. of right shares issued

New shares = (40000/ 2000000)* 600000 = 12000 shares

(b)

Market Value of stock after right offering = Market value of equity share before right + right proceeds

                                                         = (2,000000 * $34) + ( 600,000 * $30)

                                                         = $ 68,000000 + $ 18,000000

                                                         = $ 86,000000
                                                         = i.e. $ 86 millions

C-1

       Market price per share after right offering = $ 86,000000/ (2,000000+ 600,000)

                                                          = $ 33.08 per share

       Total investment in firm after right offering when we exericse presemptive rights

      = Market price per share after right offering * total no. of share after right issue

      = $ 33.08 * ( 40000+12000)

      = $ 1.72 million

C-2   When we exercise right issue

        Original Share = 40000 shares

        New share      = 12000 shares (as calculated in point (a) above)

D-1 If we decide not to exercise your presemptive rights

value of investment in the firm after the rights

=( Market value of total stock after right offering/ total no. of share after right issue) * orignal share held by us

= ($ 86000000/2600000)* 40000

= $ 1.323 million

D-2

Value of right = Market value after right offering- cost of right share

                     = $ 33.08 - $ 30

                     = $ 3.08 per share

Right sale proceed = value of right * new shares

                            = $ 3.08 * 12000

                            = $ 0.0369 million

Total value of proceed = Right sale proceed + value of investment in firm without exercise of presemptive right

                               = $ 0.0369 million + $1.323 million

                               = $ 1.3599 million

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