The Holyoke Corporation has 120,000 shares outstanding with a current market pri

Question

The Holyoke Corporation has 120,000 shares outstanding with a current market price of $8.10 per share. The company needs to raise an additional $36,000 to finance new expenditures, and has decided on a rights issue. The issue will allow current stockholders to purchase one additional share for 20 rights at a subscription price of $6 per share.

1- Calculate the ex-rights price that would make a new stockholder indifferent between buying shares at the old stock price and exercising the rights or buying the shares ex-rights.

2- If the ex-rights price were set at $7.90, would you as a potential new stockholder choose to buy shares ex-rights or buy shares at the old price and exercise your rights?

3- Suppose that the company was also considering structuring the rights issue to allow for an additional share to be purchased for 10 rights at a subscription price of $3. Prove that a stockholder with 100 shares would be indifferent between purchasing a new share for 10 rights at $3 or purchasing a new share for 20 rights at $6.

Explanation / Answer

a)The price at which you would not differntiate between two prices would be caqlculated as follows

=x *1 + 20*x-6 = 20*8.1

= 168/21 =8

b) If the potential price is 7.9 shares holder will loose because

for 20 shares he owned before right issue = 20*8.1 = 162

Now for 21 shares he owns = 21* 7.9 -6 =159.9 of 162-159.9 =2.1

loss of 2.1

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