EXTENSION 20A

RIGHTS OFFERINGS

Note: None of the problems in this chapter extension are algorithmic.

Multiple Choice: Problems

Medium:
Subscription price and ex-rights price CO Answer: d MEDIUM
1. Autore Company’s stock now sells for $50 per share, and there are
10,000,000 shares outstanding. The company plans to raise $100 million
as new equity by selling common stock. Since the preemptive right is in
the corporate charter, rights will be used. Management has decided that
the rights should be worth $1 each: Such a price would assure that most
stockholders would either exercise or sell their rights rather than just
letting them expire, yet a careless failure to use the rights would not
impose too severe a hardship on anyone. What subscription price should
Autore set for its offering to obtain the desired price of the rights,
and what will be the ex-rights stock price (Me), assuming the
theoretical relationships hold? (Hint: N = Number of old shares/Number
of new shares; Number of new shares = Dollars to be raised/Subscription
price per share.)

Sub Price Ex-rights

a. $39.65; $42.50
b. $40.25; $43.50
c. $42.65; $47.50
d. $44.55; $49.00
e. $46.65; $50.00

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.
Extension 20A: Rights Offerings Problems Page 1
 Rights offering Answer: d MEDIUM
2. To finance the construction of a new plant, Benefield Inc. must raise an
additional $10,000,000 of equity capital through the sale of common
stock. The firm currently has an EPS of $5.40 and a P/E ratio of 10,
with 1,200,000 shares outstanding. The firm will offer new shares to
its current stockholders at $40 per share. Find (1) the number of new
shares to be issued, (2) the ex-rights price of the stock (assuming that
the new market value of the stock will simply be the proceeds of the new
issue plus the current value of equity, divided by new shares
outstanding), and (3) the value of one right.

New Shs Ex-rights Rights

a. 200,000; $39.65; $1.38
b. 230,000; $40.25; $1.85
c. 230,000; $42.65; $2.16
d. 250,000; $51.59; $2.41
e. 250,000; $46.65; $2.78

Subscription price to get a specified ex-rights price CO Answer: b MEDIUM

3. To finance the construction of a new plant, Benefield Inc. must raise an
additional $10,000,000 of equity capital through the sale of common
stock. The firm currently has an EPS of $5.40 and a P/E ratio of 10,
with 1,200,000 shares outstanding. If the firm wants its ex-rights
price to be $50, what subscription price must it set on the new shares?

a. $29.55
b. $33.78
c. $39.28
d. $41.80
e. $50.00

Rights offering CO Answer c MEDIUM

4. Kotomin Inc. wants to sell stock via a rights offering. The company has
1,000,000 shares outstanding, and they sell for $90 per share. The new
issue will be used to raise $8 million of new equity, and existing
shareholders will receive one right per share held. Theoretically, if
the subscription price is $80, (1) how many new shares must be sold, (2)
how many rights per share of new stock will be required, (3) what will
the value of each right be, and (4) what will the stock price be after
the rights offering has been completed?

New Shs No. of Rights Value Ending Price

a. 100,000 8 $1.38 $88.62
b. 100,000 9 $1.05 $88.95
c. 100,000 10 $0.91 $89.09
d. 120,000 8 $1.05 $88.95
e. 120,000 10 $1.38 $88.62

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.

Page 2 Problems Extension 20A: Rights Offerings

 EXTENSION 20A
ANSWERS AND SOLUTIONS

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted
to a publicly accessible website, in whole or in part.

Extension 20A: Rights Offerings Answers Page 3

1. Subscription price and ex-rights price CO Answer: d MEDIUM

Value for one right = R = $1. Stock price, rights on = M0 = $50.

Subscription = S = ?

M 0 −S
R = N +1
$50−S
.
$1 = N +1 (1)

Number of old shares

N = Number of new shares
Number of old shares 10 ,000 ,000
Dollars raised $100 ,000 ,000
= S = S
10,000,000
= ($100,000,000)S = 0.1S. (2)

Substitute (2) into (1):

$50−S
$1 = 0.1S+1
0.1S + $1 = $50 - S
1.1S = $49
S = $44.55.

Stock price, ex-rights = Me = M0 – R = $50 – $1 = $49.

P Current market
=10 , therefore =(P )(Number of shares outstanding )
Funds to be raised $10,000 ,000 $ 5.40 value of stock
Subscription price $ 40 P=$54 .00. =$54 (1,200,000)=$64,800,000.
 Current market Proceeds from Market value of Subscription
+ −
Ex-rights price value of stock new issue Value of stock, ex-rights price
= =
per share Old shares+New shares one right Number of rights to purchase one share*
$ 64 , 800 , 000+ $ 10 , 000 ,000 $ 51. 59−$ 40 .00
= =$51. 59 . = =$2 . 41 .
1 , 200 ,000+ 250 ,000 4.8

P
=10, therefore
Number of rights required Old shares 1 ,200 , 000 $ 5.40
= = =4 . 8.
to purchase one share New shares 250 , 000 P=$54.00.

Current market
=(P )(Number of shares outstanding )
value of stock Market value of stock, ex-rights $74 ,800 ,000
=$54 (1,200,000)=$64,800,000. Old shares+New shares 1,200 ,000+X

Funds to be raised $10,000,000 $8,000,000 needed 1,000,000 rights issued

New shares 296,000 $80 /share 100,000 shares needed

M 0 −S $ 90−$ 80 $ 10
Value of a right= = = =$0 . 91 .
N +1 10+1 11

Number of old shares 10,000 ,000

M 0 −S $50−S Number of old shares Dollars raised $100 ,000 ,000 10,000,000
.
2 N +1 N +1 Number of new shares S S ($100,000,000)S

$50−S
0.1S+1 . Rights offering CO

Answer: d MEDIUM

Funds to be raised $10,000 ,000

(1) New shares = Subscription price = $ 40 = 250,000 shares.

(2) Current market value of stock where P/E = 10 and EPS = $5.40:
P
=10 , therefore
$ 5.40
P=$54 .00.

Current market
=(P )(Number of shares outstanding )
value of stock
=$54 (1,200,000)=$64,800,000.
 Current market Proceeds from
+
Ex-rights price value of stock new issue
=
per share Old shares+New shares
$ 64 , 800 , 000+ $ 10 , 000 ,000
= =$51. 59 .
1 , 200 ,000+ 250 ,000

Market value of Subscription

−
Value of stock, ex-rights price
=
one right Number of rights to purchase one share*
$ 51. 59−$ 40 .00
= =$2 . 41 .
(3) 4.8

Number of rights required =Old shares = 1 ,200 , 000 =4 . 8.

* to purchase one share New shares 250 , 000

P Current market
=10 , therefore =(P )(Number of shares outstanding )
$ 5.40 value of stock Market value of stock, ex-rights
P=$54 .00. =$54 (1,200,000)=$64,800,000. Old shares+New shares

$74 ,800 ,000 Funds to be raised $10,000,000 $8,000,000 needed 1,000,000 rights issued
1,200 ,000+X New shares 296,000 $ 80 /share 100,000 shares needed

M 0 −S $ 90−$ 80 $ 10
Value of a right= = = =$0 . 91 .
N +1 10+1 11

Number of old shares 10,000 ,000

M 0 −S $50−S Number of old shares Dollars raised $100 ,000 ,000 10,000,000
.
3 N +1 N +1 Number of new shares S S ($100,000,000)S
 P
=10 , therefore
$50−S Funds to be raised $10,000,000 $ 5.40
0.1S+1 Subscription price $ 40 P=$54.00.

Current market Proceeds from

+
Ex-rights price value of stock new issue
=
Current market per share Old shares+New shares
=(P )(Number of shares outstanding )
value of stock $ 64 , 800 , 000+ $ 10 , 000 ,000
= =$51. 59 .
=$54 (1,200,000)=$64,800,000. 1 , 200 ,000+ 250 ,000

Market value of −Subscription

Value of stock, ex-rights price
=
one right Number of rights to purchase one share*
$ 51. 59−$ 40 .00 Number of rights required =Old shares = 1 ,200 , 000 =4 . 8.
= =$2 . 41 .
4.8 to purchase one share New shares 250 , 000 .

Subscription price to get a specified ex-rights price CO Answer: b MEDIUM

(1) Current market value of stock where P/E = 10 and EPS = $5.40.
P
=10 , therefore
$ 5.40
P=$54 .00.

Current market
=(P )(Number of shares outstanding )
value of stock
=$54 (1,200,000)=$64,800,000.

Market value of stock, ex-rights

(2) Ex-rights price = Old shares+New shares
$74 ,800,000
$50 = 1,200 ,000+X ; X = 296,000 new shares issued.

Funds to be raised $10,000,000

Subscription price = New shares = 296,000 = $33.78.
$8,000,000 needed 1,000,000 rights issued M −S $ 90−$ 80 $ 10
Value of a right= 0 = = =$0 . 91 .
$80 /share 100,000 shares needed N +1 10+1 11

Number of old shares 10,000 ,000

M 0 −S $50−S Number of old shares Dollars raised $100 ,000 ,000 10,000,000
.
4 N +1 N +1 Number of new shares S S ($100,000,000)S
 P
=10 , therefore
$50−S Funds to be raised $10,000,000 $ 5.40
0.1S+1 Subscription price $ 40 P=$54.00.

Current market Proceeds from

+
Ex-rights price value of stock new issue
=
Current market per share Old shares+New shares
=(P )(Number of shares outstanding )
value of stock $ 64 , 800 , 000+ $ 10 , 000 ,000
= =$51. 59 .
=$54 (1,200,000)=$64,800,000. 1 , 200 ,000+ 250 ,000

Market value of −Subscription

Value of stock, ex-rights price
=
one right Number of rights to purchase one share*
$ 51. 59−$ 40 .00 Number of rights required =Old shares = 1 ,200 , 000 =4 . 8.
= =$2 . 41 .
4.8 to purchase one share New shares 250 , 000

P Current market
=10 , therefore =(P )(Number of shares outstanding )
$ 5.40 value of stock Market value of stock, ex-rights
P=$54 .00. =$54 (1,200,000)=$64,800,000. Old shares+New shares

$74 ,800 ,000 Funds to be raised $10,000,000

1,200,000+X New shares 296,000 . Rights offering CO

Answer: c MEDIUM

$8,000,000 needed
$80 /share = 100,000 shares needed.

1,000,000 rights issued

100,000 shares needed = 10 rights per share subscribed.

M 0 −S $ 90−$ 80 $ 10
Value of a right= = = =$0 . 91 .
N +1 10+1 11

Ending value of stock = $90 - $0.91 = $89.09.