# Using p ro as the rights on price and p s as the

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Using PROas the rights-on price, and PSas the subscription price, we can express the price per shareof the stock ex-rights as:PX= [NPRO+PS]/(N + 1)And the equation for the value of a right is:Value of a right =PROPXSubstituting the ex-rights price equation into the equation for the value of a right and rearranging, weget:Value of a right =PRO– {[NPRO+PS]/(N + 1)}Value of a right = [(N + 1)PRO– NPROPS]/(N+1)Value of a right = [PROPS]/(N + 1)16.Using the equation for valuing a stock ex-rights, we find:PX= [NPRO+PS]/(N + 1)PX= [4(\$75) + \$40]/5PX= \$68The stock is correctly priced. Calculating the value of a right, we find:Value of a right =PROPXValue of a right = \$75 – 68Value of a right = \$7
CHAPTER 19B-438So, the rights are underpriced. You can create an immediate profit on the ex-rights day if the stock isselling for \$68 and the rights are selling for \$6 by executing the following transactions:Buy four rights in the market for 4(\$6) = \$24. Use these rights to purchase a new share at thesubscription price of \$40. Immediately sell this share in the market for \$68, creating an instant \$4profit.

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Term
Spring
Professor
JoeSmolira
Tags
Generally Accepted Accounting Principles