Question

Knight Inventory Systems, Inc., has announced a rights offer. The company has announced that it will take three rights to buy a new share in the offering at a subscription price of $35. At the close of business the day before the ex-rights day, the company's stock sells for $65 per share. The next morning, you notice that the stock sells for $55 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.) Stock ex-rights What is the value of a right? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.) Value of a right Are the rights underpriced or overpriced?!

Answer 1

1.value of stock ex rights = (Stock Price - Rights subscription price per share) / (Number of rights required to buy one share + 1)

Px = [ 3($65) + 35] / (3+1) = $ 57.5

2. value of a right = (Stock price – Right subscription price) / Number of rights needed to buy a share.

= (65-35)/4 = $ 7.5

3. rights are under priced as they are sold for $ 3 but there value is $ 7.5.

4. an immediate profit can be created on the ex-rights day if the stock is selling for $55 and the rights are selling for $3 by executing the following transactions:

Buy 3 rights in the market for 3($3) = $12. Use these rights to purchase a new share at the subscription price of $35. Immediately sell this share in the market for $55, creating an instant $8 profit.