78106_20_Web_Ch20A_p01-06

78106_20_Web_Ch20A_p01-06 - WEB EXTENSION Rights Offerings...

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WEB EXTENSION 20A Rights Offerings A s we discussed in Chapter 7, common stockholders often have the right, called the preemptive right , to purchase any additional shares sold by the firm. The preemptive right may or may not be included in the corporate charter; this is a decision made by the incorporators, but it can be changed by a later vote of stock- holders. The purpose of the preemptive right is twofold. First, it protects the control position of present stockholders. Second and by far the more important reason for publicly owned companies it protects stockholders against dilution of value. These points will become clear shortly. If the preemptive right is contained in a particular firm s charter, then the com- pany must offer any newly issued common stock to existing stockholders. If the char- ter does not prescribe a preemptive right, then the firm can choose to sell to its existing stockholders or to the public at large. If it sells to the existing stockholders, the issue is called a rights offering . Each stockholder is issued an option to buy a certain number of new shares, and the terms of the option are listed on a certificate called a stock purchase right , or simply a right . Each stockholder receives one right for each share of stock held. A stockholder who does not wish to purchase any addi- tional shares can sell the rights to some other person who does want to buy the stock. Several issues confront a financial manager who is setting the terms of a rights of- fering. The various considerations can be illustrated with data from Southeast Air- lines, whose partial balance sheet and income statement are given in Table 20A-1. Southeast earns $8 million after taxes, and it has 1 million shares outstanding, so earnings per share are $8. The stock sells at 12.5 times earnings, or for $100 a share. The company announces plans to raise $10 million of new equity capital through a rights offering, and it decides to sell the new stock to shareholders for $80 a share. The questions facing the financial manager are these: 1. How many rights will be required to purchase a share of the newly issued stock? 2. What is the value of each right? 3. What effect will the rights offering have on the price of the existing stock? We next analyze each of these questions. 20.1 N UMBER OF R IGHTS N EEDED TO P URCHASE O NE N EW S HARE Southeast plans to raise $10 million in new equity and to sell the new stock at a price of $80 a share. Dividing the total funds to be raised by the subscription price gives the number of shares to be issued: 1
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Number of new shares ¼ Funds to be raised Subscription price ¼ $10 ; 000 ; 000 $80 ¼ 125 ; 000 shares The next step is to divide the number of previously outstanding shares by the num- ber of new shares to obtain the number of rights required to subscribe to a single share of the new stock. Stockholders always get one right for each share of stock they own, so Number of rights needed to buy a share of the stock ¼ Old shares New shares ¼ 1 ; 000 ; 000 125 ; 000 ¼ 8 rights
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This note was uploaded on 05/03/2010 for the course FRR 3032 taught by Professor Mr.wroshr during the Spring '10 term at Crafton Hills College.

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78106_20_Web_Ch20A_p01-06 - WEB EXTENSION Rights Offerings...

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