COMMON STOC K FIN ANCING Chapter 4 115

Illustrative Problems
ILLUSTRATION 1. Mr. Amatya, a dissatisfied stockholder of the Dabur Company, desires
representation on the board. The Dabur Company, which has 9 directors, has 1 million shares
outstanding.
a. How many shares would Mr. Amatya have to control to be assured of 1 directorship
under a majority-rule (non-cumulative) voting system?
b. Re-compute Part (a), assuming a cumulative voting system.
SOLUTION
Given,
Number of shares outstanding (N) = 1,000,000
Total number of directors to be elected (#) =9
a. Desired number of directors to be elected (des.) = 1
Number of shares required to elect desired number of directors (req.) = ?
Under non-cumulative voting:
We have,
req. = more than 50 percent shares or
= + 1 = 500,001 shares
Hence, 500,001 shares are required to elect one director with certainty.

b. Under cumulative voting:

req. = + 1= + 1 = 100,001 shares
Under cumulative voting system only 100,001 shares are required to elect one director with
certainty.
ILLUSTRATION 2. As one of the minority shareholders of the B. Corporation, Mr. 'X' is
dissatisfied with the current operations of the company. He feels that if he could gain
membership on the company's board of directors, he could persuade the company to make
improvements. The problem is that current management controls 75 percent of the stock. He
controls only 7 percent, and the balance is held by other minority shareholders. There are a
total of 500,000 voting shares. Ten directors will be elected at the next annual stockholder
meeting.
a. If voting is non-cumulative, can Mr. 'X' elect himself as a director?
b. Suppose he is able to persuade all the minority shareholders that he should be elected.
If voting is non-cumulative, can they elect him?
c. If voting is cumulative, can he elect him as a director?
d. What percent of the minority shares other than his own will he needs to have voted for
him to be certain of election?
e. What is the number of directors the minority shareholders can elect with certainty? [TU
2058 (MBA)]
SOLUTION
Given,
Number of shares outstanding (N) = 500,000 shares
Number of shares held by current management = 75% of 500,000 shares = 375,000 shares
Number of shares held by Mr. X = 7% of 500,000 shares = 35,000 shares
Control position of other minority = 100 75 7 = 18 percent
Number of shares held by other minority = 18% of 500,000 = 90,000 shares
Total number of directors to be elected (#) = 10
a. If voting is non-cumulative
Number of shares required to elect desired number of directors (req) =
= + 1 = 250,001 shares.
Under non-cumulative voting, 250,001 shares are required to elect Mr. 'X' with certainty. But
Mr. 'X' has only 35,000 shares. Therefore, he cannot be able to elect himself to the board of
directors.

b. Number of shares held by all minority shares holder = 500,000 375,000 = 125,000 shares
116 Chapter 4 C A P I T AL STRUC TURE MANAGEMENT
No, they cannot elect Mr. 'X' because minority shareholders can cast only 125,000 votes,
while majority shareholder can cast 375,000 shares.

c. If voting is cumulative
Number of shares required to elect one director (req) = = = 45,456 shares
Under cumulative voting, 45,456 shares are required to elect one director with certainty. But
Mr. 'X' has only 35,000 shares. Therefore, Mr. 'X' will not able to elect himself as a board of
director.
d. Calculation of required percentages of other minority's shares:
Extra number of shares = 45,456 35,000 = 10,456 shares
Required percentage of other minority's shares =
= = 0.1162 or 11.62%
e. Calculation of desired number of directors (des)
req =
or, 125,000 =
or, (125,000 1) 11 = des 500,000
or, des = = 2.75 directors
The minority shareholders can elect only 2 directors with certainty.
ILLUSTRATION 3. The Zoom-Company common stock is priced at Rs 150 a share on the
market. Notice is given that stockholders can purchase one new share at a price Rs 100 for
every four shares held.
a. At approximately what market price will each right sell? Why will this be the approximate
price?
b. What effect will the issuance of rights have on the original market price?
SOLUTION
Given,
Current price of stock (P0) = Rs 150
Subscription price (PS) = Rs 100
Number of rights required to purchase one new share (#) = 4

a. Approximate price of right (Vr) = ?

Vr = = = = Rs 10
Value of each right is Rs 10
The calculated value of right is approximate value because actual price is determined in the
market.
b. MPS after rights offering will decrease to the extent of value of each right.
Pe = P0 - Vr
= 150 - 10 = Rs 140
Hence, ex-right price will be 140.
ILLUSTRATION 4. Anjana Khanal's total assets consist of 490 shares of Bright Land
Corporation and Rs 2,000 in cash. Bright Land now offers stockholders one additional share at
a price of Rs 20 for each five shares held. The current market price of the stock is Rs 35.
a. What is the value of each right?
b. Prepare statements showing Khanal's total assets after the offering for each of these
alternative courses of action.
(1) She exercises all her rights.
(2) She sells all her rights.
(3) She sells 400 rights and exercises 90 rights.
(4) She neither sells nor exercises the rights. (TU 2055 & 2059)
SOLUTION
Given,
Existing number of shares = 490 shares
Cash balance = Rs 2,000
Subscription price (Ps) = Rs 20
Current market price (P0) = Rs 35
Number of rights required to purchase one new shares (#) = 5
 COMMON STOC K FIN ANCING Chapter 4 117
a. Value of right (Vr) = ?
Value of right (Vr) = = = Rs 2.50
b. Preparation of statement of wealth position if
1. If she exercises all her rights:
Existing number of shares = 490 shares
..
Total number of rights = 490 rights [ . 1 share = 1 rights]
Number of new shares that can be purchased = = = 98 shares
Market price per share after exercise of rights (P e) = P0 Vr
= Rs 35 2.50 = Rs 32.50
118 Chapter 4 C A P I T AL STRUC TURE MANAGEMENT
Statement of wealth position
Description Amount
Value of stocks [(490 + 98) shares @ Rs 32.50]............................................................................ Rs 19,110
Cash balance ................................................................................................................. Rs 2,000
Less: Cash payment for new share (98 shares @ Rs 20).....................................................1,960 40
Total wealth.................................................................................................................................. Rs 19,150
2. If she sells all her rights
Statement of wealth position
Description Amount
Value of stocks [490 shares @ Rs 32.5]........................................................................................ Rs 15,925
Cash balance ................................................................................................................. Rs 2,000
Add: Cash from sale of rights [490 rights @ Rs 2.50]............................................................1,225 3,225
Total wealth.................................................................................................................................. Rs 19,150
3. If she sells 400 rights and exercises 90 rights
Number of new shares can be purchased = = 18 shares
Statement of Wealth Position
Description Amount
Value of stocks [(490 + 18) shares @ Rs 32.50]............................................................................ Rs 16,510
Cash balance ...................................................................................................................... 2,000
Add: Cash from sale of rights (400 rights @ Rs 2.50)...........................................................1,000
Less: Cash payment for new shares [18 @ Rs 20].................................................................. 360 2,640
Total wealth.................................................................................................................................. Rs 19,150
4. If she neither sells nor exercises the rights:
Statement of Wealth position
Description Amount
Value of stocks [490 shares Rs 32.50]....................................................................................... Rs 15,925
Cash balance................................................................................................................................ 2,000
Total wealth.................................................................................................................................. Rs 17,925
ILLUSTRATION 5. Sunrise Tea Company plans to raise an additional rupee of 10 million
through rights offerings. Current market price of the company is Rs 250. It has 200,000
shares outstanding. Stockholders are offered a new share at a price of Rs 100 each.
Required:
a. How many new shares will have to be sold to raise required funds?
b. How many rights will be required to purchase a new share?
c. What will be theoretical value of rights?
d. Calculate ex-rights price.
e. Mr. Gopal Thapa's total assets consist of 100 shares of Sunrise Tea Company and cash
balance of
Rs 15,000. Prepare statements of Mr. Thapa's total assets before rights offerings.
f. Prepare statement showing Mr. Thapa's total assets after rights offerings for each of
these courses of action if,
i. he sells all his rights.
ii. he exercises all his rights.
iii. he sells 60 rights and exercises 40 rights.
SOLUTION
a. Number of new shares to be sold to raise required funds =
= = 100,000 shares
b. Number of rights required to purchase a new share = = = 2 rights
c. Theoretical value of rights (Vr) = = = = Rs 50
d. Ex-rights price (Pe) = P0 Vr
= Rs 250 Rs 50 = Rs 200

e. Statement of Gopal Thapa's assets (Before rights offerings)

Description Amount
 COMMON STOC K FIN ANCING Chapter 4 119
Value of stocks (100 shares @ Rs 250)......................................................................................... Rs 25,000
Cash balance ............................................................................................................................... 15,000
Total assets.................................................................................................................................. Rs 40,000
f. Preparation of Statement of Wealth position after rights offerings
i. If he sells all his rights
Statement of Gopal Thapa's assets
Description Amount
Value of stocks (100 shares @ Rs 200)......................................................................................... Rs 20,000
Cash balance ............................................................................................................... Rs 15,000
Add: Cash received from sale of rights (100 rights @ Rs 50)................................................5,000 20,000
Total assets.................................................................................................................................. Rs 40,000
ii. If he exercises all his rights
Statement of Gopal Thapa's assets
Description Amount
Value of stocks [(100 + 100/2) shares @ Rs 200].......................................................................... Rs 30,000
Cash balance................................................................................................................ Rs 15,000
Less: Cash payment for new shares [100/2 shares @ Rs 100].............................................5,000 10,000
Total assets.................................................................................................................................. Rs 40,000
iii. If he sells 60 rights and exercise 40 rights
Statement of Gopal Thapa's assets
Description Amount
Value of stocks [(100 + 40/2) shares @ Rs 200]............................................................................ Rs 24,000
Cash balance................................................................................................................ Rs 15,000
Add: Cash from sale of rights [60 rights @ Rs 50]................................................................. 3,000
Less: Cash payment for new shares [40/2 shares @ Rs , 100].............................................2,000 16,000
Total assets.................................................................................................................................. Rs 40,000
ILLUSTRATION 6. The stock of the National Corporation is selling for Rs 50 per share. The
company then issues rights to subscribe to one new share at Rs 40 for each five rights held.
a. What is the theoretical value of a right when the stock is selling rights-on?
b. What is the theoretical value of one share of stock when it goes ex-rights?
c. What is the theoretical value of a right when the stock sells ex-rights at Rs 50?
d. Shiva Mishra has Rs 1,000 at the time National stock goes ex-rights at Rs 50 per share.
He feels that the price of the stock will rise to Rs 60 by the time the rights expire.
Compute his return on his
Rs 1,000 if he (1) buys National stock at Rs 50, or (2) buys the rights at the price
computed in part c, assuming his price expectations are valid.
SOLUTION
Given,
Selling price of stock (P0) = Rs 50
Subscription price (Ps) = Rs 40
Number of rights required to purchase one new share (#) = 5
a. When the stock is selling rights on,
Theoretical value of right (Vr) = = = Rs 1.67
Hence, theoretical value of right is Rs 1.67 when the stock is selling rights on:
b. When it goes ex-rights,
Theoretical value of a share when it goes ex-right (Pe) = = = Rs 48.33
Alternatively,
Ex-rights value of a share (Pe) = P0 Vr
= Rs 50 1.67 = Rs 48.33
c. Ex-rights stock price (Pe) = Rs 50
Value of right(Vr) =?
Vr = = = Rs.2
d. Calculation of return
Selling price of stock at the end of the period = Rs. 60
1. If fund is used to purchase share,
120 Chapter 4 C A P I T AL STRUC TURE MANAGEMENT
Purchase price = Rs 50
Number of shares that can be purchased = = = 20 shares
Cash received from sale of share at the end of period = Rs 60 20 = Rs 1,200
Total return in Rs = Value of shares at the end of period Investment
= Rs 1,200 Rs 1,000 = Rs 200
Total return in percent = = = 0.20 or 20%
2. If fund is used to purchase rights,
Value of right (Vr) = Rs 2
Funds available = Rs 1,000
Number of rights that can be purchased = = = 500 rights
Value of rights when MPS increases to Rs 60
Vr = = = Rs 4
Value of total rights = Rs 4 500 = Rs 2,000
Total return in Rs = Rs 2,000 Rs 1,000 = Rs 1,000
Total return in percent = = 1 or 100%
ILLUSTRATION 7. The Miller Company has the balance sheet and income statement in table
given below. The company plans to raise an additional Rs 5 million through a rights offering:
the additional funds will continue to earn 10.5 percent. The price-earnings ratio is assumed to
remain at 15 times, the dividend payout will continue to be 56 percent, and the 40 percent
tax rate will remain in effect. (Do not attempt to use the formula given in the chapter.
Additional information is given here that violates the other things constant" assumption
inherent in the formula.)
a. Assuming subscription price of Rs 50 a share:
1. How many additional shares of stock will have to be sold?
2. How many rights will be required to purchase one new share?
3. What will be the new earnings per share?
4. What will be the new market price per share?
5. What will be the new dividend per share if the dividend payout ratio is maintained?
b. Suppose you hold 100 shares of Miller stock before the rights offering. After you exercise
your rights, what is the value of your position?
The Miller Company's Balance Sheet before rights offering
Total debt (6%)................................. Rs 7,000,000
Common stock (100,000 shares)...... 3,000,000
Retained earnings ........................... 4,000,000
Total assets.................................... Rs 14,000,000 Total liabilities and capital ............ Rs 14,000,000
The Miller Company Income Statement
Earnings rate: 10.5% on total assets.............................................................................................
Total earnings ............................................................................................................................... Rs 1,470,000
Interest on debt ............................................................................................................................. 420,000
Income before taxes...................................................................................................................... Rs 1,050,000
Taxes (40% rate assumed)............................................................................................................ 420,000
Earnings after taxes ...................................................................................................................... Rs 630,000
Earnings per share........................................................................................................................ Rs 6.30
Dividends per share (56% of earnings).......................................................................................... Rs 3.53
Price earnings ratio........................................................................................................................ 15 times
Market price per share................................................................................................................... Rs 94.50

SOLUTION
Given,
Additional funds to be raised = Rs 5 million
Return on additional fund = Rs 10.5 percent
Price earnings (P/E) ratio = 15 times
Dividend payout ratio (DPR) = 56 percent
Tax rate (T) = 40 percent
Subscription price = Rs 50
a. 1.Calculation of additional number of shares
 COMMON STOC K FIN ANCING Chapter 4 121
Additional number of shares to be issued = = = 100000 shares
2. Calculation of number of rights required to buy one new share:
Number of rights required to buy one new share = = = 1 right
3. Calculation of new earnings per share:
Income Statement
Amount
Earnings before interest and tax (EBIT) (Rs 14,70,000 + 10.5% of Rs 5 million)........................... Rs 1,995,000
Less: Interest on debt (6% of Rs 7,000,000).................................................................................. 420,000
Earnings before tax (EBT)............................................................................................................. Rs 1,575,000
Less: Tax @ 40%........................................................................................................................... 630,000
Earnings after tax (EAT)................................................................................................................. Rs 945,000
Number of shares outstanding (100,000 shares + 100,000 shares)............................................... 200,000
Earnings per share (EPS).............................................................................................................. Rs 4.725
4. Calculation of new market price per share
P/E ratio........................................................................................................................................ 15
Earning per share (EPS)................................................................................................................ Rs 4.725
Market price per shares (MPS) = EPS P/E ratio = Rs 4.725 15............................................... Rs 70.875
122 Chapter 4 C A P I T AL STRUC TURE MANAGEMENT
5. Calculation of new dividend per share
Dividend payout ratio (DPR).......................................................................................................... 56%
Earning per share (EPS)................................................................................................................ Rs 4.725
Dividend per share (DPS) = DPR EPS....................................................................................... Rs 2.646
b. Calculation of total value of position
Existing number of shares ............................................................................................................ 100
Number of new shares .................................................................................................................. 100
Market price per shares (MPS)...................................................................................................... Rs 70.875
Total number of shares (N) = Existing number of stock + Number of new shares........................... 200
Total value of position = Total number of shares MPS= 200 70.875......................................... Rs 14,175

Problems
PROBLEM 1. Mrs. Gauri Aryal, a dissatisfied stockholder of the Triveni Gas
Voting Rights Company, desires representation on the board. The Company, which has
10 directors, has 8,00,000 shares outstanding.
a. How many shares would Mrs. Aryal have to control to be assured of 1
directorship under a majority-rule voting system?
b. How many shares would Mrs. Aryal have to control to be assured of 1
directorship under a cumulative voting system?
PROBLEM 2. Surya Nepal Limited has a nine-person board and 500,000 shares of
Voting Rights common stock outstanding. It is chartered with a cumulative voting rule.
Mr. Bijay Karki directly or indirectly controls 240,000 shares. Because he
disagrees with present management, he wants a slate of his own
directors on the board.
a. If all directors are elected once a year, how many directors can he
elect?
b. If directors' terms are staggered so that only three are elected each
year, how many can he elect?
PROBLEM 3. As one of the minority shareholders of the B. Corporation, you are
Voting Rights dissatisfied with current operations of the company. You feel that if you
could gain membership on the company's board of directors, you could
pursue the company to make improvements. The problem is that current
management controls 70 percent of the stock, you control only 10
percent and the balance is held by the other minority shareholders. There
are a total of 500,000 voting shares. Ten directors will be elected at the
next annual stockholder meeting.
a. If voting is non-cumulative, can you elect yourself director?
b. Suppose you are able to persuade all the minority shareholders that
you should be elected. If voting is non-cumulative, can they select
you?
c. If voting is cumulative, can you elect yourself as a director?
d. What percent of minority shares other than you own will you need to
have voted for you to be certain of election?
e. What is the number of directors the minority shareholders can elect
with certainty?
PROBLEM 4. The Zenith Company common stock is priced at Rs 130 a share on the
Value of a Right market. Notice is given that stockholders can purchase one new share at
a price Rs 100 for every two shares held.
 COMMON STOC K FIN ANCING Chapter 4 123
a. At approximately what market price will each right sell?
b. What effect will the issuance of rights have on the original market
price?
PROBLEM 5. The stock of the Jhapa Electronic Company is selling for Rs 180 per share.
Value of a Right The company issues rights to subscribe for one additional share of stock
at Rs 140 a share, for each three held. Compute the theoretical value of :
a. A right when the stock is selling rights-on.
b. One share of stock when it goes ex-rights.
c. A right when it goes ex-rights and the actual market price goes to Rs
172 per share.
PROBLEM 6. The Bikash Furniture Company has grown rapidly during the past five
Value of a Right years. Recently, company has discovered some good investment
opportunity. It plans to raise an additional Rs 10,00,000 through rights
offerings. Current market price of the stock is Rs 150. But subscription
price is set at Rs 100 which is equal to its par value. Company has 40,000
shares outstanding.
Required:
a. Number of new shares to be issued.
b. Number of rights required to purchase one new share.
c. Theoretical value of each right.
d. Theoretical value of a share when stock goes ex-right.
e. Theoretical value of a right when the stock sells ex-rights and the
actual market price goes to Rs 145 per share.
PROBLEM 7. The Shikhar Company plans to raise an additional Rs 10 million through a
Value of a Right rights offering. Current market price is Rs 110. But existing shareholders
are offered one new share at Rs 50. Currently company has 10,00,000
shares outstanding.
a. How many additional shares of stock will have to be sold?
b. How many rights will be required to purchase one new share?
c. What will be the value of each right?
d. What will be the market price per share after rights offering?
e. Suppose you hold 100 shares of Shikhar Companys stock and have
Rs 5,000 cash balance before the rights offering. Show your wealth
position before and after rights offering assuming you exercise your
rights.
PROBLEM 8. Ganesh Thapa's total assets consist of 500 shares of Delta Company and
Rights Offerings Rs 10,000 in cash. The company now offers stockholders one additional
share at a price of Rs 150 for each two shares held. The current market
price of the stock is Rs 300.
a. What is the value of each right?
b. Prepare statements showing Thapa's total assets before the offering.
c. Prepare statements showing Thapa's total assets after the offering
for each of these alternative courses of action.
1. He exercises all his rights.
2. He sells all his rights.
3. He sells 300 rights and exercises 200 rights.
4. He neither sells nor exercises the rights.
PROBLEM 9. The stock of the Omega Company is selling for Rs 150 per share. The
Value of a Right company then issues rights to subscribe to one new share at Rs 100 for
124 Chapter 4 C A P I T AL STRUC TURE MANAGEMENT
each four rights held.
a. What is the theoretical value of a right when the stock is selling
rights-on?
b. What is the theoretical value of one share of stock when it goes ex-
rights?
c. What is the theoretical value of a right when the stock sells ex-rights
at Rs 150?
d. Saroj Koirala has Rs 15,000 at the time Omega stock goes ex-rights
at Rs 150 per share. He feels that the price of the stock will rise to Rs
180 by the time the rights expire. Compute his return on his Rs
15,000 if he (1) buys Omega stock at Rs 150, or (2) buys the rights at
the price computed in part c, assuming his price expectations are
valid.
PROBLEM 10. Standard Tea Company (STC) plans to raise an additional rupee of 5
Rights Offering
million through rights offering. Current market price of the company is Rs
300. It has 100,000 shares outstanding. Stockholders are offered a new
share at a price of Rs 200 each.
Required:
a. How many new shares will have to be sold to raise required funds?
b. How many rights will be required to purchase a new share?
c. What will be theoretical value of rights?
d. Calculate ex-rights price.
e. Mr. Sagar Hamal's total assets consist of 100 shares of STC. Prepare
statements of Mr. Hamal's total assets before rights offerings.
f. Prepare statement showing Mr. Hamal's total assets after rights
offerings for each of these courses of action if,
i. he sells all his rights.
ii. he exercises all his rights.
iii. he sells 60 rights and exercises 40 rights.
iv. he neither exercises nor sells the rights.
PROBLEM 11. The Seven Spring Company plans to sell an additional 2 million shares of
Value of a Right common stock through a rights offering. The company currently has 20
million shares outstanding. Each shareholder will receive one right for
each shares currently held. Therefore, each right will enable shareholders
to purchase 0.10 shares. Seven Springs common stock currently is selling
for Rs 25 per share and the subscription price of the rights will be Rs 22
per share.
a. Calculate the theoretical value of the right for both the rights-on and
ex-rights cases.
b. Determine the amount that the market price of the company's stock
is expected to drop on the ex-rights date, assuming all other things
are equal.
c. If the market price of Seven Spring common stock increases to Rs 30
per share, determine the theoretical value of the rights (right-on
case).
PROBLEM 12. Star Company is proposing a rights offering. Presently there are 240,000
Value of a Right shares outstanding at Rs 80 each. There will be 60,000 new shares
offered at Rs 60 each.
a. What is the new market value of the company?
b. How many rights are associated with one of the new shares?
 COMMON STOC K FIN ANCING Chapter 4 125
c. What is the ex-rights price?
d. What is the value of a right?
e. Why might a company have a rights offering rather than a general
cash offer?
PROBLEM 13. The Everest Gas Company has announced a rights offer to raise Rs 60
Rights Offering million for a new Gas Station. The stock currently sells for Rs 60 per
share, and there are 4.8 million shares outstanding.
a. What is the maximum possible subscription price? What is the
minimum?
b. If the subscription price is set at Rs 50 per share, how many shares
must be sold?
c. How many rights will it take to buy one share?
d. What is the ex-rights price?
e. What is the value of a right?
f. Show how a shareholder with 1,000 shares before the offering and no
desire (or money) to buy additional shares is not harmed by the
rights offer.
PROBLEM 14. HT Company has announced a rights offer. The company has announced
Valuing a Right that it will take four rights to buy a new share in the offering at a
subscription price of Rs 35. At the close of business the day before the ex-
rights day, the company's stock sells for Rs 70 per share. The next
morning, you notice that the stock sells for Rs 63 per share and the rights
sell for Rs 6 each. Are the stock and/or the rights correctly priced on the
ex-rights day? Describe a transaction in which you could use these prices
to create an immediate profit.
PROBLEM 15. Sagar Joshi owns stock in Alpha Company. The company is planning a
Rights Offering rights offering in which seven shares must be owned to buy one
additional share at a price of Rs 15. The company's stock currently sells
for Rs 63 per share.
a. What is the value of a right?
b. At the time of the offering announcement, Joshi's assets considered
of Rs 1,500 in cash and 490 shares of the company. List and show the
value of Joshi's assets prior to the ex-rights date.
c. List and show the value of Joshi's assets after the ex-rights date if the
company's stock sells for Rs 60 per share on that date and Joshi
exercises all his rights.
d. List and show the value of Joshi's assets if he sells the rights on the ex-
rights date.
PROBLEM 16. The financial manger of Dhaulagiri Company is concerned about the
Rights Offering impact of its new rights offering on the wealth position of the firm's
shareholders. It is common for new equity issues to lower of the stock
price. There are currently 500,000 shares of common stock outstanding.
Since the subscription price of the rights issue determines the number of
common shares to be issued, the financial manager is interested in high
subscription price. Given that the company needs Rs 1.5 million of new
equity financing, answer the following questions:
a. Suppose shareholder A owns 100 shares and the stock is currently
selling at a right- on price of Rs 30 per share. Determine shareholder
A's wealth tied up in company's stock.
b. Given a subscription price of Rs 25, first determine the price of a
126 Chapter 4 C A P I T AL STRUC TURE MANAGEMENT
right and then shareholder A's wealth assuming the rights are sold.
c. Recalculate (b), assuming a subscription price of Rs 10.
d. From your answers to b and c, does the subscription price affect the
ex-rights market price of a share of stock? Does it affect shareholder
wealth?
PROBLEM 17. The Metal Company has the balance sheet and income statement in table
Rights Offering
given below. The company plans to raise an additional Rs 5 million
through a rights offering: the additional funds will continue to earn 10.5
percent. The price-earnings ratio is assumed to remain at 15 times, the
dividend payout will continue to be 56 percent, and the 40 percent tax
rate will remain in effect. (Do not attempt to use the formula given in the
chapter. Additional information is given here that violates the other things
constant" assumption inherent in the formula.)
a. Assuming subscription price of Rs 25 a share:
1. How many additional shares of stock will have to be sold?
2. How many rights will be required to purchase one new share?
3. What will be the new earnings per share?
4. What will be the new market price per share?
5. What will be the new dividend per share if the dividend payout
ratio is maintained?
b. Suppose you hold 100 shares of Metal stock before the rights
offering. After you exercise your rights, what is the value of your
position?

The Metal Company's Balance Sheet before rights offering

Total debt (6%)............................. Rs 7,000,000
Common stock (100,000 shares). 3,000,000
Retained earnings ....................... 4,000,000
Total assets................................ Rs 14,000,000 Total liabilities and capital ........ Rs 14,000,000

The Metal Company Income Statement

Earnings rate: 10.5% on total assets
Total earnings .................................................................................................................. Rs 1,470,000
Interest on debt ............................................................................................................... 420,000
Income before taxes......................................................................................................... Rs 1,050,000
Taxes (40% rate assumed)............................................................................................... 420,000
Earnings after taxes ........................................................................................................ Rs 630,000
Earnings per share........................................................................................................... Rs 6.30
Dividends per share (56% of earnings)............................................................................ Rs 3.53
Price earnings ratio.......................................................................................................... 15 times
Market price per share..................................................................................................... Rs 94.50

Mini Case
NE Company has grown rapidly during the past 5 years. Recently, the company
has found good investment opportunity. The company plans to raise Rs
50,000,000 to finance the project. The additional fund (new fund) will also earn
20 percent return. Discussions with an investment banker, two alternatives are
found feasible: rights offering or public offerings.
Alternative 1: Rights offering: Company can issue new shares to existing
shareholders at Rs 250 on pro-rata basis.
Alternative 2: Public offering: Company can sell new common stock in the
open market at Rs 350. However, company will incur 5 percent underwriter's
compensation.
 COMMON STOC K FIN ANCING Chapter 4 127
Partial Balance Sheet of NE Company
Current liabilities............................ Rs 15,000,000
10% Long-term debt...................... 25,000,000
Common stock .............................. 20,000,000
(2,00,000 shares @ Rs 100)
Retained earnings ......................... 40,000,000
Total assets ............................. Rs 100,000,000 Total liabilities & capital.............. Rs 100,000,000
Partial Income Statement of NE Company
EBIT [20% of total assets]........................................................................................................ Rs 20,000,000
Less: Interest on debt............................................................................................................... 2,500,000
EBT.......................................................................................................................................... 17,500,000
Less: Tax @ 40%..................................................................................................................... 7,000,000
EAT (or NI)............................................................................................................................... Rs 10,500,000
Number of shares outstanding................................................................................................. 200,000 Shares
EPS ......................................................................................................................................... Rs 52.50
Market price per share............................................................................................................. Rs 400
Answer the following questions:
a. What do mean by rights offering and public offering?
b. Why does a firm prefer rights offering instead of public offering?
c. What is the subscription price under the rights offering? How is it set?
d. How many new shares must be issued under rights offering?
e. How many rights are required to purchase one new share?
f. What is the formula value of each right?
g. What will be the stock price when it goes ex-right?
i. How many new shares must be issued under public offering?
j. Agrawal Group wants to elect one director. Total number of directors to be
elected is seven and voting in cumulative. How many shares are required
to elect one director
(i) at present (ii) after rights offering and (iii) after public offering?
k. What will be the approximate market price after public offering?
l. Show the effect of rights offering and public offerings on balance sheet and
income statement.
m. Sanjib Pradhan's total assets consist of 1,000 shares of NE Company.
Prepare statements of Mr. Pradhan's total assets before rights offerings.
n. Prepare statement showing Mr.Pradhan's total assets after rights offerings
for each of these courses of action if,
i. he sells all his rights.
ii. he exercises all his rights.
iii. he sells 600 rights and exercises 400 rights.
iv. he neither exercises nor sells the rights.
o. Does Mr. Pradhan's ownership and control dilute under rights offering?
p. What will be the impact on ownership and control power of Mr. Pradhan
under public offerings?

128 Chapter 4 C A P I T AL STRUC TURE MANAGEMENT
4. COMMON STOCK FINANCING
1. a. 400,001 shares b. 72,729 shares
2. a. 4 b. 1
3. a. No, because you have only 50,000 shares b. No, they can't elect you
c. Yes, shares needed to elect you = 45,456; d. No additional shares are required;
e. 3 directors.
4. a. Rs 10 b. Rs 120
5. a. Rs 10 b. Rs 170 c. Rs 10.67
6. a. 10,000 shares b. 4 rights c. Rs 10 d. Rs 140
e. 11.25
7. a. 200,000 shares b. 5 rights c. Rs 10 d. Rs 100
e. Rs 16,000, Rs 16,000
8. a. Rs 50 b. Rs 160,000 c. 1. Rs 160,000; 2. Rs 160,000;
3. Rs 160,000 4. Rs 135,000
9. a. Rs 10 b. Rs 140 c. Rs 12.5 d. Rs 3,000 & 20%; Rs 9,000 &
60%
10. a. 25,000 shares b. 4 rights c. Rs 20 d. Rs 280
e. Rs 30,000 f. Rs 30,000 Rs 30,000, Rs 30,000, Rs 28,000
11. a. Re 0.2727 b. Rs 24.7273 (decreased by Re. 0.2727) c. Re 0.7273
12. a. Rs 22,800,000 b. 4 rights c. Rs 76 d. Rs 4
13. a. Maximum price = Current MPS (Rs 60); Minimum price = Par value;
b. 1.2 million shares c. 4 rights d. Rs 58 e. Rs 2
14. Rs 7 and Rs 63; Hence, stock is correctly priced but right is under-priced.
15. a. Rs 6 b. Rs 32,370 c. Rs 34,050 d. 34,050
16. a. Rs 3,000
b. Rs 0.5359 and Rs 3,000
c. Rs 4.6154 and Rs 3,000
17. a. (1) 200,000 shares (2) 0.5 rights
(3) Rs 3.15 (4) Rs 47.25 (5) Rs 1.764
b. Rs. 14,175 (Value of stock)