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.) $\text {Sub Price}$ $\quad$ $\text {Ex-rights}$
a. $\$ 39.65 \quad\quad \$ 42.50$
b. $\$ 40.25 \quad \quad\$ 43.50$
c. $\$ 42.65 \quad\quad \$ 47.50$
d. $\$ 44.55 \quad\quad \$ 49.00$
e. $\$ 46.65 \quad\quad \$ 50.00$

Question

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.)

\text {Sub Price}

\quad

\text {Ex-rights}

a.

\$ 39.65 \quad\quad \$ 42.50

b.

\$ 40.25 \quad \quad\$ 43.50

c.

\$ 42.65 \quad\quad \$ 47.50

d.

\$ 44.55 \quad\quad \$ 49.00

e.

\$ 46.65 \quad\quad \$ 50.00

Quizplus · Accepted Answer

The Answer is D
Explanation:
Value for one right = R = $1. Stock price, rights on = M₀ = $50. Subscription = S = ?

\begin{array} { l } \mathrm { R } = \frac { \mathrm { M } _ { 0 } - \mathrm { S } } { \mathrm { N } + 1 } \\\$ 1 = \frac { \$ 50 - \mathrm { S } } { \mathrm { N } + 1 }\end{array}

(1)

\begin{aligned}N & = \frac { ext { Number of old shares } } { ext { Number of new shares } } \\& = \frac { \frac { ext { Number of old shares } } { ext { 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{aligned}

(2)
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.

There Are 10,000,000 Shares Outstanding of O'Connell Co Sub Price\text {Sub Price}Sub Price

There Are 10,000,000 Shares Outstanding of O'Connell Co $\text {Sub Price}$