During recent years, your company has made considerable use of debt financing, to the extent that it
Question:
This means that even a profitable project will decrease earnings per share if it is financed with new equity. For example, the firm is considering a project which costs $400 but has a value of $500 (i.e. an NPV of 100), and which will increase total earnings by $60 per year. If it is financed with equity, the $400 will require approximately 200 shares, thus bringing the total shares outstanding to 1200. The new earnings will be $660, and earnings per share will fall to $.55. The president of the firm argues that the project should be delayed for three reasons.
a) It is too expensive for the firm to issue new debt.
b) Financing the project with new equity will reduce earnings per share because the market value of equity is less than book value.
c) Equity markets are currently depressed. If the firm waits until the market index improves, the market value of equity will exceed the book value and equity financing will no longer reduce earnings pershare.
Capital structure refers to a company’s outstanding debt and equity. The capital structure is the particular combination of debt and equity used by a finance its overall operations and growth. Capital structure maximizes the market value of a...
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Financial Theory and Corporate Policy
ISBN: 978-0321127211
4th edition
Authors: Thomas E. Copeland, J. Fred Weston, Kuldeep Shastri