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.

b. If Todd invests his \)4,800 in Gallagher rights and the price of Gallagher stock rises to $70 per share ex-rights, what would his dollar profit on the rights be? (First compute profit per right.)

Short answer

Answer

Todd will be able to generate a profit of $1,041.60.

Step-by-step solution

Information available

Money available for investment = $4,800

Subscription price = $48

Price of one share = $70

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 $3.14.

$\begin{array}{rcl}\mathbf{\text{R}}& \mathbf{=}& \frac{{\mathbf{\text{M}}}_{\mathbf{0}}\mathbf{-}\mathbf{\text{S}}}{\mathbf{\text{N}}\mathbf{+}\mathbf{1}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{70}\mathbf{-}\mathbf{\$}\mathbf{48}}{\mathbf{6}\mathbf{+}\mathbf{1}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{22}}{\mathbf{7}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{3}\mathbf{.}\mathbf{14}\end{array}$

Calculation of the profit generated with increased share price

The profit generated will be $1,41.60.

$\begin{array}{rcl}\mathbf{\text{Profit per right}}& \mathbf{=}& \mathbf{\text{New value of one right}}\mathbf{-}\mathbf{\text{Old value of one right}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{3}\mathbf{.}\mathbf{14}\mathbf{-}\mathbf{\$}\mathbf{2}\mathbf{.}\mathbf{58}\\ & \mathbf{=}& \mathbf{\$}\mathbf{0}\mathbf{.}\mathbf{56}\end{array}$

$\begin{array}{rcl}\mathbf{\text{Profit generated}}& \mathbf{=}& \mathbf{\text{Profit per right}}\mathbf{-}\mathbf{\text{Number of rights that can be purchased}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{0}\mathbf{.}\mathbf{56}\mathbf{\times }\mathbf{1}\mathbf{,}\mathbf{860}\\ & \mathbf{=}& \mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{041}\mathbf{.}\mathbf{60}\end{array}$