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.

e. What would be the answer to part c if the price of Gallagher’s stock falls to \)40 per share ex-rights?

Short answer

Answer

The loss generated will be -$1,872.

Step-by-step solution

Information available

Money available for investment = $4,800

Subscription price = $48

Price of one share = $66

New share price = $40

Number of rights that can be purchased = 1,860

Calculation of the profit generated

The loss generated will be -$1,872.

$\begin{array}{rcl}\mathbf{\text{Loss per share}}& \mathbf{=}& \mathbf{\text{New share price}}\mathbf{-}\mathbf{\text{Old share price}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{40}\mathbf{-}\mathbf{\$}\mathbf{66}\\ & \mathbf{=}& \mathbf{-}\mathbf{\$}\mathbf{26}\end{array}$

$\begin{array}{rcl}\mathbf{\text{Loss generated}}& \mathbf{=}& \mathbf{\text{Loss per share}}\mathbf{\times }\mathbf{\text{Number of shares}}\\ & \mathbf{=}& \mathbf{-}\mathbf{\$}\mathbf{26}\mathbf{\times }\mathbf{72}\\ & \mathbf{=}& \mathbf{-}\mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{872}\end{array}$