question archive ABC Industries is considering an investment that requires the firm to issue new equity
ABC Industries is considering an investment that requires the firm to issue new equity
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ABC Industries is considering an investment that requires the firm to issue new equity. The
project will cost $100, but will add $120 to the firm’s value. Although management believes
the firm’s value is $1,000 without the new project, outside investors value the firm at $600
without the project. If the firm currently has 100 shares outstanding, how many new shares
must it issue to finance the project? Now assume that the true value of the firm will become
known to the market shortly after the new equity has been issued. What will the firm’s stock
price be at this time if it chooses to finance this new investment? What will the stock price be
if it chooses to pass up the investment?
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Answer:
Vaue of firm as per outside investors = $600
No of shares outstanding = $100
Per Value of share = 600 / 100 = $6
Amount of money to be raised = $100
No of new share required to finance the project = $100/$6 = 16.67 shares = 17 shares (Round Off)
Now the true value of firm is known to the market so:
Revised value of the firm = $1000
Revised value of stock = $1000/100 = $10 (Firm's stock price once true value of firm is known to the market)
No of shares required to raise project cost i.e. $100 = $100 / $10 = 10 shares
Stock price if firm choose to pass the investment ?
Projected value of firm = $1000 + $120 = $1120
Total no of shares in market = 110
Revised stock price = $1120/110 = $10.18
