1. The Somerset Company has warrants outstanding that expire in three years.
Each warrant entitles the holder to purchase one share of common stock at an exercise price of $40 per share. Determine the formula value and premium over the formula value if the respective prices of common stock and warrants are:
a. $32 per share and $1.50 per warrant
b. $40 per share and $3.50 per warrant
c. $48 per share and $10 per warrant
2. The Seven Springs Company plans to sell an additional 2 million shares of com- mon stock through a rights offering. The company currently has 20 million shares outstanding. Each shareholder will receive one right for each share currently held.
Therefore, each right will enable shareholders to purchase 0.10 shares. Seven Springs common stock currently is selling for $25 per share and the subscription price of the rights will be $22 per share.
a. Calculate the formula value of the right for both the rights-on and ex-rights cases.
b. Determine the amount that the market price of the company's stock is expected to drop on the ex-rights date, assuming all other things are equal.
c. If the market price of Seven Springs common stock increases to $30 per share, determine the formula value of the rights (rights-on case).