Question

Larry Nelson holds 1,000 shares of General Electric common stock. The annual shareholders meeting is being held soon, but as a minor shareholder, Larry doesn’t plan to attend. Larry did not sell his shares but gave his voting rights to the management group running GE. Larry must have signed a that gives the management group control over his shares. Larry also holds 2,000 shares of common stock in a company that only has 20,000 shares outstanding. Currently, the company’s stock is valued at $43.00 per share. The company needs to raise new capital to invest in its future production activities. The company is anticipating issuing 5,000 new shares at a price of $34.40 per share. Larry worries about the value of his investment. Larry’s current investment in the company is worth $ . If the company issues its new shares and Larry makes no additional investments in the company, then his investment will be worth $ . This scenario is an example of . Larry could be protected if the firm’s corporate charter includes a provision. If Larry exercises the provisions in the corporate charter to protect his stake, his investment value in the firm will become

Answer 1

Larry must have signed a PROXY AGREEMENT that gives the management group control over his shares.

A proxy agreement is generally used for stockholders voting procedures, they basically grant another person the right to vote on behalf of another stockholder.

Larry's current investment in the company is $86,000.

= 2,000 stocks x $43 = $86,000

If the company issues new shares and Larry makes no additional purchase, Larry's investment will be worth $82,560.

company's new market value = (20,000 x $43) + (5,000 x $34.40) = $1,032,000

new stock price = $1,032,000 / 25,000 stocks = $41.28

= $41.28 x 2,000 = $82,560

This scenario is an example of STOCK DILUTION.

The stock price will lower because the increase in the company's value is less than proportional to the increase in the number of stocks.

Larry could be protected if the firm's corporate charter includes a PREEMPTIVE provision.

Preemptive rights give current stockholders the right to purchase more stocks (in case the company issues more stocks) before any outside investors.

If Larry exercises the provisions in the corporate charter to protect his stake, his investment value in the firm will become $103,200.

= [(5,000 / 10) x $34.40] + $86,000 = $17,200 + $86,000 = $103,200