4. A firm has 100,000 shares of stock currently outstanding. Each share currentl

Question

4. A firm has 100,000 shares of stock currently outstanding. Each share currently has a true value of $70. Suppose the firm issues 20,000 shares of new stock at the following prices: (a) $75, (b) $65, and (c) $40. The firm takes the funds raised in the issue and invests in securities (i.e., a 0 NPV project). What will be the effect of each of the alternative offering prices on the long-run market price of the shares after the issue assuming that in the long-run the market price for the stock will reflect the stock’s true value? (Ignore issues such as taxation and transactions costs)

Explanation / Answer

Ans) Outstanding Shares = 100000 Shares Ture Value = $70 NPV = 0 New Shares = 20000 Shares New Share Price = (a) 75 (b) 65 © 40 Option A Change in the price of the share = (100000*70+20000*75)/120000 New Price of the Share $    70.83 Option B Change in the price of the share = (100000*70+20000*65)/120000 New Price of the Share $    69.17 Option C Change in the price of the share = (100000*70+20000*40)/120000 New Price of the Share = $    65.00 Stock true value are $70.83, $69.17 and $65.00

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