Chapter 5: 14BP-a (page 569)

Todd Winningham IV has $4,800 to invest. He has been looking at Gallagher Tennis Clubs Inc. common stock. Gallagher has issued a rights offering to its common stockholders. Six rights plus $48 cash will buy one new share. Gallagher’s stock is selling for $66 ex-rights.
a. How many rights could Todd buy with his $4,800? Alternatively, how many shares of stock could he buy with the same $4,800 at $66 per share?

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Answer

Todd can purchase 1,860 rights and 72 shares with an investment of $4,800.

Step by step solution

Money available for investment = $4,800

Subscription price = $48

Price of one share = $66

Rights required to purchase a new share = 6

The value of one right is $2.58.

$\begin{array}{rcl} R & = & \frac{M_{0} - S}{N + 1} \\ = & \frac{$ 66 - $ 48}{6 + 1} \\ = & \frac{$ 18}{7} \\ = & $ 2.58 \end{array}$

The number of rights that can be purchased is 1,860

$\begin{array}{rcl} Number of rights & = & \frac{Investment amount}{Value of one right} \\ = & \frac{$ 4, 800}{$ 2.58} \\ = & 1, 860 \end{array}$

Todd can purchase 72 shares with the investment of $4,800 at the price of $66.

$\begin{array}{rcl} Number of shares & = & \frac{Investment}{Price of one shares} \\ = & \frac{$ 4, 800}{$ 66} \\ = & 72 \end{array}$

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Liabilities and stockholder’s claims
Liabilities
Accounts payable	\(2,800,000
First lien, secured by machinery and equipment	\)900,000
Senior unsecured debt	\(2,200,000
Subordinated debenture	\)1,700,000
Total liabilities	\(7,600,000
Stockholder’s claims
Preferred stock	\)250,000
Common stock	\(650,000
Total stockholder’s claims	\)900,000
Total liabilities and stockholder’s claims	$8,500,000