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 $61. At the close of business the day before the ex-rights day, the company’s stock sells for $85 per share. The next morning, you notice that the stock sells for $70 per share and the rights sell for $2 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?

Value of a right

$

  

Are the rights underpriced or overpriced?

(Click to select)UnderpricedOverpriced

  

What is the amount of immediate profit you can make on ex-rights day per share?

Immediate profit

$

Answer 1

Solution:
1.	Stock ex-rights	$ 79
Working Notes:
	Stock ex-rights = [n x ROP + SP] /(n+1)
	n= no. of Rights required to buy a Right share=3
	ROP = Right on price or Cum-Right price = $85
	SP = Subscription price = $61
	Stock ex-rights = [n x ROP + SP] /(n+1)
	=[3x85 + 61 ] /(3+1)
	=[255+61]/4
	=316/4
	=$79
2.	Value of a right	$15
Working Notes:
	Value of a right = ROP - Ex Right price
	ROP = Right on price or Cum-Right price = $85
	Ex-rights price	$70
	(after right selling price of stock is $70)
	Value of a right = ROP - Ex Right price
	= $85 - $70
	=$15
3.	The rights are underpriced.
Working Notes:
	Since,
	The rights sell for $2 each.
	But
	Theoretical value of a Right = $15 as calculated in 2.
Hence,
	The rights are underpriced.
4.	Immediate profit	$3
Working Notes:
	Buy 3 Rights for $2x3 = $6
	and pay subscription for a share =$61
	Immediately sell for $70
	Immediate profit= Sell price - Subscription price - Payment for Rights
	= $70 - 61 - 6
	= 70-67
	=$3 per share
Please feel free to ask if anything about above solution in comment section of the question.