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 $60 to $48 ($60 is the rights-on price; $48 is the ex-rights price,also known as the when-issued price). The company is seeking $12 million in additional funds with a per-share subscription price equal to $30. 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

624,000

600,000

576,000

362,000

630,000

Answer 1

B. 600,000

To calculate the price of the stock ex-rights, we can find the number of shares a shareholder will have ex-rights, which is:

P_X = $48 = [N($60) + $30]/(N + 1)

N = 1.5

The number of new shares is the amount raised divided by the per-share subscription price, so:

Number of new shares = $12,000,000/$30 = 400,000

And the number of old shares is the number of new shares times the number of shares ex-rights, so:

Number of old shares = 1.5(400,000) = 600,000