Knight Inventory Systems, Inc., has announced a rights offer. The company has an
ID: 2756239 • Letter: K
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 $29. 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 $44 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.) What is the value of a right? Are the rights underpriced or overpriced? What is the amount of immediate profit you can make on ex-rights day per share?Explanation / Answer
Answer:
Using the equation for valuing a stock ex-rights, we find:
PX = [NPRO + PS]/(N + 1)
PX = [4($50) + $29]/5 = $45.8
Answer: Value of a right = PRO – PX
Value of a right = $50 – 45.8 = $4.2
Answer: the rights are underpriced.
Answer: Immediately sell this share in the market for $72, creating an instant $4.2 profit.
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