You are CEO of a high-growth technology firm. You plan to raise $180 million to fund an expansion by issuing either new shares or new debt. With the expansion, you expect earnings next year of $24 million. The firm currently has 10 million shares outstanding, with a price of $90 per share. Assume perfect capital markets.
a. If you raise the $180 million by selling new shares, what will the forecast for next year’s earnings per share be?
b. If you raise the $180 million by issuing new debt with an interest rate of 5%, what will the forecast for next year’s earnings per share be?
c. What is the firm’s forward P/E ratio (that is, the share price divided by the expected earnings for the coming year) if it issues equity? What is the firm’s forward P/E ratio if it issues debt? How can you explain the difference?