PRINCIPLES OF CORPORATE FINANCE
PRINCIPLES OF CORPORATE FINANCE
13th Edition
ISBN: 9781264052059
Author: BREALEY
Publisher: MCG
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Chapter 15, Problem 29PS

Dilution Here is recent financial data on Pisa Construction Inc.

Chapter 15, Problem 29PS, Dilution Here is recent financial data on Pisa Construction Inc. Pisa has not performed

Pisa has not performed spectacularly to date. However, it wishes to issue new shares to obtain $80,000 to finance expansion into a promising market. Pisa’s financial advisers think a stock issue is a poor choice because, among other reasons, “sale of stock at a price below book value per share can only depress the stock price and decrease shareholders’ wealth.” To prove the point they construct the following example: “Suppose 2,000 new shares are issued at $40 and the proceeds are invested. (Neglect issue costs.) Suppose return on investment does not change. Then

Book net worth = $ 580 , 000 Total earnings = .08 ( 580 , 000 ) = $ 46 , 400 Earnings per share = 46 , 400 12 , 000 = $ 3.87

Thus, EPS declines, book value per share declines, and share price will decline proportionately to $38.70.”

Evaluate this argument with particular attention to the assumptions implicit in the numerical example.

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