Big Box retailing has a market capitalization of $500 million and 4 million shares outstanding. In order to finance its growth, the management of Big Box plans to raise further capital through a rights issue. All shareholders will be issued ten rights to purchase ten shares at a price of $1.00 per share. How much money will this raise, if all shareholders exercise their rights?

Question

BlackTom AI · Accepted Answer

To evaluate this rights issue, start by identifying the key numbers: there are 4 million shares outstanding, and each shareholder receives ten rights to purchase ten new shares at $1 per share.
Option 1: $40.0 million. This aligns with the straightforward calculation below: total rights = 4,000,000 shares × 10 rights per share = 40,000,000 rights. If every right is exercised to purchase a new share at $1, the funds raised = 40,000,000 × $1 = $40,000,000, which matches this option.
Option 2: $80.0 million. This would imply either twice as many new shares were issued or the exercise price was effectively $2 per share. Since the exercise price is given as $1 and the number of rights yields 40 million potential new shares, $80 million would require 80 million new shares at $1, which is not supported by the rights per existing share.
Option 3: $20.0 million. This would occur if only half of the rights were exercised or if the rights entitlement translated into half as many new shares as calculated. However, the problem states that all shareholders exercise their rights, so we should count all available rights and corresponding shares, not a subset.
Option 4: $60.0 million. This would require 60 million new shares at $1 each, which again contradicts the given ratio of 10 rights to purchase 10 shares per 4 million existing shares. The arithmetic shows 40 million possible new shares, not 60 million.
In summary, the correct interpretation is that each existing share with its 10 rights enables one new share per right, yielding 40 million new shares at $1 each, for a total of $40 million. The other options result from overcounting or undercounting the rights or misapplying the exercise price.

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