A firm has no debt. Existing assets generate earnings (E) of $32 million per year forever. Discount rate is 16%. The firm has 6.25 million shares (n) outstanding. Now the firm plans to invest I=$25 million in a new project. Project will generate $10 million in new earnings forever per year. The firm will issue Δn new shares at new price P* to finance the project. What is the new price per share, P*, that the new shares be issued if the new shares are priced efficiently?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
A firm has no debt. Existing assets generate earnings (E) of $32 million per year forever. Discount rate is 16%. The firm has 6.25 million shares (n) outstanding. Now the firm plans to invest I=$25 million in a new project. Project will generate $10 million in new earnings forever per year. The firm will issue Δn new shares at new price P* to finance the project. What is the new price per share, P*, that the new shares be issued if the new shares are priced efficiently?
Given:
Earnings = $32 million
Discount rate =16%
Shares out standing = 6.25 million
Investment = $25 million
Cash flows = $10 million
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