In general, you should note the following about rights issues:

Setting a lower subscription price makes the deal more likely to get done

The deal not getting done will reflect badly on management

It is less likely that underpriced firms will have a significant price drop (which results in the deal not getting done).

Given this information and what you've learned in the course, give a qualitative explanation for the following evidence:

Firms who announce cash offers suffer a decrease in stock price.

Firms who announce rights issues enjoy a stock price increase.

For firms who offer rights issues, higher subscription prices lead to higher stock prices.

b) You are consulting the CFO of Hotels R Us (HRU) -- a hotel chain. The CFO wants to build a new $100 million wing. The NPV of the project, if all equity financed, is -$18 million. But HRU is currently completely unlevered; consequently, the expansion can be financed completely with the issue of risk-free debt. Assuming that the relative tax advantage of debt is 21%, the CFO tells you that the present value of the tax shields garnered by the financing of the project is $21 million. Therefore, the adjusted present value of the project is $3 million and so the project should be undertaken. Do you agree? Explain.

c) Tomatoes Inc. announces that it will acquire Sauce Inc. by paying each Sauce shareholder $40 per share financed with cash. Bondholders of each firm will have to exchange their old claims for bonds in the new firm, Tomato Sauce Inc. The CEO's of the two firms argue that the new bonds will have a higher market value than the sum of the old bonds. Is this possible? Tell me when you think it would be true and when you think it would be false.