Cool Water Ltd has 15 million common shares outstanding and long-term debt with a market value of $25 million. The Board of Directors has asked you to investigate the possibility of having a rights issue to raise enough funds to pay off the debt. Based on the current value of the company’s shares, the company’s investment dealer has recommended a subscription price of $5 per share for the new shares.

Required:

a) Determine the number of new shares that would have to be issued and the number of rights that would be required to purchase one new share. (3 marks)

b) Assuming a “right-on” price of $6.00 determine the theoretical value of a right during the rights-on period (3 marks)

c) Kevin owns 900 shares in the company is trying to decide whether to exercise his rights or sell them. He has come to you for advice and wants to know which alternative with result in greater wealth. Advise Kevin, providing calculations to justify the advice given. (8 marks)