Question

Red Shoe Co. has concluded that additional equity financing will be needed to expand operations and that the needed funds will be best obtained through a rights offering. It has correctly determined that as a result of the rights offering, the share price will fall from $100 to $90 ($100 is the rights-on price; $90 is the ex-rights price,also known as the when-issued price). The company is seeking $15 million in additional funds with a per-share subscription price equal to $50. How many shares are there currently, before the offering? (Assume that the increment to the market value of the equity equals the gross proceeds from the offering.)

rev: 09_20_2012

1,260,000

1,248,000

1,200,000

1,152,000

224,000

Answer 1

Let's say there are currently N shares of the company in the market

Total current market cap = N * Current Stock Price = 100N

Number of new shares issued = Additional Funds raised / Subscription price per share = 15000000/50 = 300,000

New share price = $90

Total number of shares outstanding after rights issue = N + 300000

New Market Cap = 90 * (N + 300000)

This should be equal to previous market cap + additional funds raised

90 * (N + 300000) = 100N + 15000000

10N = 27000000 - 15000000 = 12000000

N = 1200000 (i.e. 1.2mn)

Thus, total number of shares currently before the offering = 1.2 million