Company A is a small sized , full equity company and it will continue to stick to
Question:
Company A is a small sized , full equity company and it will continue to stick to the full equity financing policy in the future ) . The company is considering an investment project . The project requires an initial capital of 230 , and the firm has no cash or marketable securities , so the firm must issue stock to finance the investment project . The following table describes the company's values without the project and the value of a project at the end of the time period under the consideration for equally probable high and low status . Suppose that the market investors are well informed of the project values as shown in the table . The company has the choice of taking or not taking the project.
Answer the following questions assuming the discount rate is zero:
State of the Economy Low High
Asset Value without investment 113 325
Project NPV 18 25
a ) If the firm announces that it will take the project , what will be the company's expected value after the announcement ?
b ) And if it announces not taking the project , what will be the company's values at high and low status and the company's expected value after the announcement ?
c ) If the firm issues stock to the market new investors other than the old equity holders at the price of old share's expected value computed in b ) , and undertakes the project , what will be the company's ratio of old equity share number and new equity share number ? ( Hint : The ratio of share numbers equals the ratio of equity values at the time of issuing )
d ) If the future distribution is based on the ratio between old share number and new share number , what will be the intrinsic value of the old equity value corresponding to the two economic statuses ?
e ) Is there any chance that the old equity holders will prefer not issuing and give up the positive investment opportunity ? If so , what is the condition and explain why under the situation of this case?
Foundations of Financial Management
ISBN: 978-1259024979
10th Canadian edition
Authors: Stanley Block, Geoffrey Hirt, Bartley Danielsen, Doug Short, Michael Perretta