New Stock Price

[allalongthewatchtowe]

Hello All,

This question is really killing me.

The company is entirely equity-financed. Market capitalization = $50M and has 10M shares outstanding. It announces a new project with NPV of $32M. The upfront cost of the project is $110M. What is the old and new stock price before and after the announcement of the project respectively? How much equity will need to be raised to finance the project? Assume no taxes, and perfect capital markets.

Here’s what I did:

Old stock price = $50M/10M = $5

Project’s future cash flows = NPV + Investment = $142M

Therefore, new stock price = ($50M + $142 M)/10M = $19.2

Therefore, new shares issued = $110M/ $19.2 = 5.7M shares.

Unfortunately, my answers are wrong.

2 Questions:

#1- The official answer takes into account only the earnings of the project and not the present value of the future cash flows. Why? If this were an IPO (that is if the firm were private and this was the only project available in the company), we would have based the stock price on future cash flow and not based on just the earnings. Isn’t it? Why is there a difference in the two methods?

#2- Why do we think about new shares after increasing the stock price? As in, why not say new shares issued = $110M/$5 (using the previous stock price)? I am curious.

Can someone please help me?

I am really lost.

[FratBoyDeluxe]

Share Px = $5

Number of shares issued = 110/5= 22M

New stock price = (50 + 32) / (10 + 22) = 2.56

I think, what’s the answer?

[allalongthewatchtowe]

Nope. the answer is $8.1 for stock price, and 13.6M shares. I am waiting for experts to help me out.

[allalongthewatchtowe]

@allalongthewatchtowe

Hello All,

This question is really killing me.

The company is entirely equity-financed. Market capitalization = $50M and has 10M shares outstanding. It announces a new project with NPV of $32M. The upfront cost of the project is $110M. What is the old and new stock price before and after the announcement of the project respectively? How much equity will need to be raised to finance the project? Assume no taxes, and perfect capital markets.

Here’s what I did:

Old stock price = $50M/10M = $5

Project’s future cash flows = NPV + Investment = $142M

Therefore, new stock price = ($50M + $142 M)/10M = $19.2

Therefore, new shares issued = $110M/ $19.2 = 5.7M shares.

Unfortunately, my answers are wrong.

2 Questions:

#1- The official answer takes into account only the earnings of the project and not the present value of the future cash flows. Why? If this were an IPO (that is if the firm were private and this was the only project available in the company), we would have based the stock price on future cash flow and not based on just the earnings. Isn’t it? Why is there a difference in the two methods?

#2- Why do we think about new shares after increasing the stock price? As in, why not say new shares issued = $110M/$5 (using the previous stock price)? I am curious.

Can someone please help me?

I am really lost.

Any help on my two questions?

[allalongthewatchtowe]

Anyone who could help this lost soul?

[tickersu]

@allalongthewatchtowe

Hello All,

This question is really killing me.

The company is entirely equity-financed. Market capitalization = $50M and has 10M shares outstanding. It announces a new project with NPV of $32M. The upfront cost of the project is $110M. What is the old and new stock price before and after the announcement of the project respectively? How much equity will need to be raised to finance the project? Assume no taxes, and perfect capital markets.

Here’s what I did:

Old stock price = $50M/10M = $5

Project’s future cash flows = NPV + Investment = $142M

Therefore, new stock price = ($50M + $142 M)/10M = $19.2

Therefore, new shares issued = $110M/ $19.2 = 5.7M shares.

Unfortunately, my answers are wrong.

I would say old price is 50M/10 M =5

new price is (50+32)/10 = $ 8.2 per share

New shares issued is 110 M/8.2 = 13.415 M shares

That was my intuition when I saw the problem. If it were multiple choice, I’d pick the closet one to that combo.

You don’t consider the old stock price to issue shares, because the price change is immediate (assuming efficient markets). Once the company announces a new project, the market would bump the price of this stock up to reflect the value added from the project. This is before any new shares are actually sold. When the company goes to issue new shares, it’s at the higher price, otherwise the company would be expropriating value from the original shareholders by allowing new shareholders to buy in for cheaper than the true value.

2 Questions:

#1- The official answer takes into account only the earnings of the project and not the present value of the future cash flows. Why? If this were an IPO (that is if the firm were private and this was the only project available in the company), we would have based the stock price on future cash flow and not based on just the earnings. Isn’t it? Why is there a difference in the two methods?

I’m not entirely sure I understand what you’re asking, so I’ll leave that for someone else.

#2- Why do we think about new shares after increasing the stock price? As in, why not say new shares issued = $110M/$5 (using the previous stock price)? I am curious.

See my answer above.

Can someone please help me?

I am really lost.

[MrSmart]

You only add the equity portion of the project’s NPV to the market cap. So in this case, the new stock price should be $8.2

110/8.1= 13.58M shares are needed to finance the project.

The new share price is used instead, because the company issues new shares to finance the project which has a NPV of $32m, so the total value of the company increases, and this is reflected in the PV of the stock, which should also be it’s price at par (issue).

Earnings and cashflow to equity should converge in any financial statement, this is more evident in a finite project, than a growing going concern company. Earnings smooth out the cash flows, which should not make a big difference in the time value of money if proper accounting treatments were used. That’s not to say that it’s the same, but almost the same. Discounting cashflows directly is a more accurate valuation.

[tickersu]

@MrSmart

You only add the equity portion of the project’s NPV to the market cap. So in this case, the new stock price should be $8.2

110/8.1= 13.58M shares are needed to finance the project.

Where are you getting 8.1 from? P1 is $8.2, so they issue $110M/$8.2 per share = X Million shares… what am I missing?

The new share price is used instead, because the company issues new shares to finance the project which has a NPV of $32m, so the total value of the company increases, and this is reflected in the PV of the stock, which should also be it’s price at par (issue).

Earnings and cashflow to equity should converge in any financial statement, this is more evident in a finite project, than a growing going concern company. Earnings smooth out the cash flows, which should not make a big difference in the time value of money if proper accounting treatments were used. That’s not to say that it’s the same, but almost the same. Discounting cashflows directly is a more accurate valuation.

[MrSmart]

Yea, it’s $8.2, and not $19.2.

That should still answer your question.

[tickersu]

@MrSmart

Yea, it’s $8.2, and not $19.2.

That should still answer your question.

This isn’t my question, I’m not the OP. You said divide 110 by $8.1. If you read my response (prior) to your answer, I provided the same solution as you, except dividing 110 by 8.2. I’m confident in my solution for the OP, so I was asking why you’re dividing by 8.1…

[MrSmart]

@tickersu

@MrSmart

Yea, it’s $8.2, and not $19.2.

That should still answer your question.

This isn’t my question, I’m not the OP. You said divide 110 by $8.1. If you read my response (prior) to your answer, I provided the same solution as you, except dividing 110 by 8.2. I’m confident in my solution for the OP, so I was asking why you’re dividing by 8.1…

I wrote the new stock price is $8.2, then a typo in the calculation.

[tickersu]

@MrSmart

@tickersu

@MrSmart

Yea, it’s $8.2, and not $19.2.

That should still answer your question.

This isn’t my question, I’m not the OP. You said divide 110 by $8.1. If you read my response (prior) to your answer, I provided the same solution as you, except dividing 110 by 8.2. I’m confident in my solution for the OP, so I was asking why you’re dividing by 8.1…

I wrote the new stock price is $8.2, then a typo in the calculation.

Got, it! I was only curious because the OP said the soluion used 8.1, so I figured it should be clarified.