Question

Knight Inventory Systems, Inc., has announced a rights offer. The company has announced that it will take five rights to buy a new share in the offering at a subscription price of $33. At the close of business the day before the ex-rights day, the company’s stock sells for $54 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?
Immediate profit $

Answer 1

1) What is the value of a right?

value of a right = (stock price - right subscription price) / number of rights needed to buy a share

value of a right = ($54 - $33) / 5 = $21 / 5 = $4.20

2) Are the rights underpriced or overpriced?

the rights are underpriced because they are sold at $2 each, and their fair price is $4.20

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

you buy 5 rights and use them to buy one stock at $33, total cost = (5 x $2) + $33 = $43. Immediately sell the stock at $44, and you can earn $1 per stock.