Question

The shareholders of Xyzrox have a preemptive right. Xyzorx has decided to sell 1,000,000 new shares of common stock. They currently have 1,000,000 shares outstanding. The preemptive right allows the current Xyzorx shareholders to:

i)Sell all of their current shares back to the company at the current market price.

ii) Purchase 1 share of stock in the new common stock sale for each share they own.

iii) Convert their current common stock shares into an equal number of preferred stock shares.

iv) Convert their common stock shares into bonds of an equal value.

*Please give a short explanation for the option you choose as to why it is correct. Without explanation please do not answer.

Answer 1

Preemptive rights are a clause in an option, security or merger agreement that gives the investor the right to maintain his or her percentage ownership of a company by buying a proportionate number of shares of any future issue of the security.

So if an investor holds 1 share in the stock of X, then he has a right to maintain the same percentage of holding after the new issue. Also, it is mandatory for the company to first offer the new shares to the current holder, then only the new shares can be offered to the general public, hence the answer is:-

ii) Purchase 1 share of stock in the new common stock sale for each share they own.