Suppose you own 40,000 shares of common stock in a firm with 500,000 total share

Question

Suppose you own 40,000 shares of common stock in a firm with 500,000 total shares outstanding. The firm announces a plan to sell an additional 100,000 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.

If you decide not to exercise your preemptive rights, what is your investment in the firm after the rights offering? 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? Show your work.

Explanation / Answer

Suppose you own 40,000 shares of common stock in a firm with 500,000 total shares outstanding. The firm announces a plan to sell an additional 100,000 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.

If you decide not to exercise your preemptive rights, what is your investment in the firm after the rights offering?

Market value of the stock after the rights offering = (Total Market Value before right + Market capital raised through right )/Total Outstanding Share

Market value of the stock after the rights offering = (40*500000 + 35*500000)/1000000

Market value of the stock after the rights offering = $ 37.50

Investment in the firm after the rights offering = 40000*37.50 = $ 1,500,000

If you sell your rights rather than use them, how much money will you receive from the rights sale

Money will you receive from the rights sale = 40000*5 = $ 200,000

and what is the total value of your proceeds from the sale of the rights offering plus your investment in the firm? Show your work.

Total value of your proceeds from the sale of the rights offering plus your investment in the firm = 1500000+ 200000

Total value of your proceeds from the sale of the rights offering plus your investment in the firm = $ 1700000

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