Exam 18: Extension 18 A: Rights Offerings

There are 10,000,000 shares outstanding of O'Connell Co.'s stock,which now sells for $50 per share.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 O'Connell set for its offering to obtain the desired price of the rights,and what will be the ex-rights stock price (M_e),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

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Question 1

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D
Value for one right = R = $1.Stock price,rights on = M₀ = $50.Subscription = S = ?
(1)
$\begin{array}{l}\mathrm{R}=\frac{\mathrm{M}_{0}-\mathrm{S}}{\mathrm{N}+1} \\\$ 1=\frac{\$ 50-\mathrm{S}}{\mathrm{N}+1}\end{array}$

(2)
$\mathrm{N}=\frac{\text { Number of old shares }}{\text { Number of new shares }}$
$\begin{array}{l}=\frac{\frac{\text { Number of old shares }}{\text { Dollars raised }}}{\mathrm{S}}=\frac{\frac{10,000,000}{\$ 100,000,000}}{\mathrm{~S}} \\=\frac{10,000,000}{(\$ 100,000,000) \mathrm{S}}=0.1 \mathrm{~S} .\end{array}$
Substitute (2)into (1):
$\begin{aligned}1 &=\frac{\$ 50-\mathrm{S}}{0.1 \mathrm{~S}+1} \\0.1 \mathrm{~S}+\$ 1 &=\$ 50-\mathrm{S} \\1.1 \mathrm{~S} &=\$ 49 \\\mathrm{~S} &=\$ 44.55\end{aligned}$ Stock price,ex-rights = M_e = M₀ -R = $50 -$1 = $49.

Pietersen Corporation must raise an additional $10,000,000 of equity capital through the sale of common stock in order to finance the construction of a new plant.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. 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

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Question 2

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(1) New shares $= \frac { \text { Funds to be raised } } { \text { Subscription price } } = \frac { \$ 10,000,000 } { \$ 40 } = 250,000$ shares.
(2) Current market value of stock where $\mathrm{P} / \mathrm{E}=10$ and $\mathrm{EPS}=\$ 5.40$ :
$\begin{array}{c}\frac{\mathrm{P}}{\$ 5.40}=10, \text { therefore } \\\mathrm{P}=\$ 54.00\end{array}$

Current market $=(\mathrm{P})$ (Number of shares outstanding $)$ value of stock
$=\$ 54(1,200,000)=\$ 64,800,000 .$
Current market Proceeds from Ex-rights price $=\frac{\text { value of stock new issue }}{\text { Old shares }+\text { New shares }}$
$=\frac{\$ 64,800,000+\$ 10,000,000}{1,200,000+250,000}=\$ 51.59$
(3)
$\begin{array} { l } \text { Value of one right } = \frac { \begin{array} { l } \text { Market value of } - \text { Subscription } \\\text { stock, ex-rights }\end{array} } { \begin{array} { c } \text { Number of righs to } \\\text { purchase one share* }\end{array} } \\= \frac { \$ 51.59 - \$ 40.00 } { 4.8 } = \$ 2.41 .\end{array}$

Ritzer Company has 1,000,000 shares of stock outstanding that sell for $90 per share.The company wants to sell stock via a rights offering.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 a. 100,000 8 b. 100,000 9 c. 100,000 10 d. 120,000 8 e. 120,000 10 Value Ending Price \ 1.38 \ 88.62 \ 1.05 \ 88.95 \ 0.91 \ 89.09 \ 1.05 \ 88.95 \ 1.38 \ 88.62

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Question 3

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$\frac { \$ 8,000,000 \text { needed } } { \$ 80 / \text { share } } = 100,000 \text { shares needed. }$
$\frac { 1,000,000 \text { rights issued } } { 100,000 \text { shares needed } } = \mathbf { 1 0 } \text { rights per share subscribed. }$
$\text { Value of a right } = \frac { \mathrm { M } _ { 0 } - \mathrm { S } } { \mathrm { N } + 1 } = \frac { \$ 90 - \$ 80 } { 10 + 1 } = \frac { \$ 10 } { 11 } = \$ 0.91$ Ending value of stock = $90 -$0.91 = $89.09.

To finance the construction of a new plant,Pietersen Corporation 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?

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Question 4

An Overview of Financial Management and the Financial Environment

Financial Statements, cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds, bond Valuation, and Interest Rates

Risk and Return

Valuation of Stocks and Corporations

Financial Options and Applications in Corporate Finance

The Cost of Capital

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Corporate Valuation and Financial Planning

Agency Conflicts and Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Supply Chains and Working Capital Management

Multinational Financial Management

Public and Private Financing: Initial Offerings, seasoned Offerings, and Investment Banks

Lease Financing

Hybrid Financing: Preferred Stock, warrants, and Convertibles

Dynamic Capital Structures

Mergers and Corporate Control

Enterprise Risk Management

Bankruptcy, reorganization, and Liquidation

Portfolio Theory and Asset Pricing Models

Real Options

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Pension Plan Management

Financial Management in Not For Profit Businesses

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