Managerial Finance 476(II)
11. Todd Winningham IV has $4,000 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 $38 cash will buy one new share. Gallagher's stock is selling for $50 ex-rights.
a. How many rights could Todd buy with his $4,000? Alternatively, how many shares of stock could he buy with the same $4,000 at $50 per share?
b. If Todd invests his $4,000 in Gallagher rights and the price of Gallagher stock rises to $59 per share ex-rights, what would his dollar profit on the rights be? (First compute profits per right.)
c. If Todd invests his $4,000 in Gallagher stock and the price of the stock rises to $59 per share ex-rights, what would his total dollar profit be?
d. What would be the answer to part b if the price of Gallagher's stock falls to $30 per share ex-rights instead of rising to $59?
e. What would be the answer to part c if the price of Gallagher's stock falls to $30 per share ex-rights?
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Solution Preview
The purpose of the question is to make you calculate the value of each share rights of a company, and then challenge you to calculate if it would be more profitable to invest in the rights of the company or to invest in the stocks ex- rights. The question then gives you with two scenarios, first when the price of the stock rises after the rights issue and another scenario when the price of the stock falls. In each case the question wants you to determine the per share and per rights profit/loss and the total profit/loss.
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<br>The question makes some assumptions; the problem assumes that Todd can make purchases, sales and rights transactions whenever he wants at the prevailing market rates. This is always possible and transactions may take place at different prices than those quoted. Also, the ...