Question

Knight Inventory Systems, Inc., has announced a rights offer. The company has announced that it will take four rights to buy a new share in the offering at a subscription price of $27. At the close of business the day before the ex-rights day, the company’s stock sells for $50 per share. The next morning, you notice that the stock sells for $43 per share and the rights sell for $3 each.

What is the value of the stock ex-rights? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

What is the value of a right? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

What is the amount of immediate profit you can make on ex-rights day per share? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

Answer 1

Solution :-

(a)

Value of the Stock Ex-Right =  [ NPRO + PS ] / ( N + 1 )

= [ 4 ( $50 ) + $27 ] / ( 4 + 1 )

= $227 / 5

= $45.40

(b)

Value of Right = $50 - $45.40 = $4.60

(c)

So, the rights are under priced. You can create an immediate profit on the ex-rights day if the stock is selling for $45.40 and the rights are selling for $3 by executing the following transactions:

Buy 4 rights in the market for 4 * ($3) = $12.

Use these rights to purchase a new share at the subscription price of $27.

Immediately sell this share in the market for $45.40,

Creating an instant $6.40 profit

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