Question

A corporation with common stock outstanding declares a nontaxable dividend payable in rights to subscribe to common stock on June 30 of the current year. Each right entitles the holder to purchase one share of stock for $25. One right is issued for every share of stock owned. Nexsen owns 100 shares of stock purchased ten years ago for $1,000. At the time of the distribution of the rights, the market value of the common stock is $40 per share, and the market value of the rights is $5 per right. Nexsen receives 100 rights. On September 30, he exercises 75 of the rights and sells the remaining 25 rights for $6 per right. If Nexsen does not allocate his original stock basis to the rights, his basis of the new stock is:

A) $1,000
B) $2,500
C) $4,000
D) $6,000

Answer 1

If Nexsen does not allocate his original stock basis to the rights, his basis of the new stock will be $4,000. Thus the correct option is C. $4,000.

Step-by-step explanation:

When Nexsen exercises the rights and purchases additional shares, the basis of the new stock is determined by allocating a portion of the original stock basis to the newly acquired shares.

In this case, Nexsen originally purchased 100 shares for $1,000, resulting in a per-share basis of $10 ($1,000/100). When he exercises 75 rights, he acquires 75 new shares. The allocated basis for these new shares is calculated by multiplying the per-share basis by the number of new shares acquired: $10 x 75 = $750.

Therefore, the basis of the 75 new shares is $750. Additionally, Nexsen sells 25 rights for $6 per right, generating $150 (25 x $6) in income. This income is added to the basis of the newly acquired shares, resulting in a total basis of $900 ($750 + $150) for the 75 new shares.

As a result, the basis of the new stock, considering the allocation of the original stock basis to the rights, is $900 x 4 (for the total number of new shares: 75 + 25) = $3,600. Adding the original stock basis of $1,000 yields a final basis of $4,000 for Nexsen's holdings after exercising the rights.

In summary, by properly allocating the original stock basis to the newly acquired shares, the correct basis for the new stock is $4,000 (Option C).

Thus the correct option is C. $4,000.