Oswego Manufacturing Company has decided to sell additional common stock through a rights offering. The company has 50 million shares outstanding and plans to sell an additional 5 million shares through the rights offering. Each shareholder will receive one right for each share currently held, and thus each right will entitle shareholders to purchase 0.1 shares. Oswego's common stock is currently selling at $50 a share, and the subscription price of the rights will be $45 a share.
a. Calculate the formula value of the right for both the rights-on and the ex-rights cases.
b. How much is the market price of the company's stock expected to drop on the exrights date, all other things being equal? Why?
c. If the market price of Oswego's common stock increases to $52 a share, what will the formula value of the right be (rights-on case)?
d. Discuss the trend of the right's market price over its life, assuming the company's common stock continues to trade in the $50 range. (No numerical calculations are necessary for this part of the problem.)