In-Class Example 9_2: Raising Capital 1

A firm has no debt. Existing assets generate earnings (E) of $10 million per year forever. Discount rate is 10%. Firm has 5 million shares (n) currently selling at $20 per share. Now firm plans to invest I=$30 million in a new project. Project will generate $4 million in new earnings forever per year. The firm will issue Δn new shares at to finance the project.

a) What is the NPV of this project?

b) What is the price ( that the new shares will be issued if the new shares are priced correctly?

c) How many shares should the firm issue?

d) What is the new EPS? And what would be the expected return for new shareholders?

e) Now let’s assume that the company can issue the new share at $24. How many shares does the company has to issue?

f) Eventually after the company will be recognized to be worth $140 million, what would be the share price?

g) What is the expected return for new shareholders when the new issue was sold for $24 per share?