Question

Common stock of TarHeals Medicinal Products, ltd. has a current market value of $23. TarHeals is planning to issue transferable put rights to its shareholders, with four put rights required to sell one share back to the firm for $30. I.M confused has a tax basis of 17.50 per share for his shares of TarHeals. If I.M's capital gains tax rate is 14% what would you expect a put right to be worth for him?

Answer 1

IM's tax basis = $ 17.5

IM's sale price = $ 30

For tax calculation purpose, we need to calculate the capital gains. For that, the tax basis becomes the cost and hence,

Capital Gain = Sale Price - Tax Basis

Capital Gain = $ 30 - $ 17.5

Capital Gain = $ 12.5

Now, IM's capital gains tax rate is 14% which means:

Net Realization for IM = Capital Gain * ( 1 - tax rate )

Net Realization for IM = $ 12.5 * (1 - 14%)

Net Realization for IM = $ 10.75

As mentioned in the question, four put rights are required to sell one share back to TarHeals. Which means, after excercising 4 Put Rights, Net Realization for IM will be $ 10.75.

4 Put Rights Value = $ 10.75

Value of 1 Put Right = $ 10.75 / 4 = $ 2.6875

Value of Put Right = $ 2.69 ....Answer