Question

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.

d. What would be the answer to part b if the price of Gallagher’s stock falls to \)40 per share ex-rights instead of rising to $70?

Short answer

Answer

Todd will lose all his investment if the price of the share declines to $40.

Step-by-step solution

Information available

Money available for investment = $4,800

Subscription price = $48

Price of one share = $66

New share price = $40

Old value of one right = $2.58

Number of rights that can be purchased = 1,860

Calculation of the value of one right

The value of one right is -$1.14 and this will result in loss of investment by Todd.

$\begin{array}{rcl}\mathbf{\text{R}}& \mathbf{=}& \frac{{\mathbf{\text{M}}}_{\mathbf{0}}\mathbf{-}\mathbf{\text{S}}}{\mathbf{\text{N}}\mathbf{+}\mathbf{1}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{40}\mathbf{-}\mathbf{\$}\mathbf{48}}{\mathbf{6}\mathbf{+}\mathbf{1}}\\ & \mathbf{=}& \frac{\mathbf{-}\mathbf{\$}\mathbf{8}}{\mathbf{7}}\\ & \mathbf{=}& \mathbf{-}\mathbf{\$}\mathbf{1}\mathbf{.}\mathbf{14}\end{array}$