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Hello, I asked this question before and you asked if that was from the book, not it is not. It is from my assignment and those are only details given. I wrote the question down below again:
The firm needs £1 M for an investment
Current share number: 1M, share price £16
WACC is the smallest when debt ratio is 1.4
so what will happen to stock price 1) when issuing new equity to raise the money 2) and when issuing debt
(consider pecking order theory and asymmetric information)I am so confused about using the numbers – like what am I supposed to do with the given figures especially with the target ratio and the amount needed. I mean we know that the stock price will fall when issuing new equity but I am confused about what will happen to share price when issuing new debt.And again, I do not what I have to do with those numbers to explain my point.
But I repeat what I wrote before.
What happens to the share price depends on what returns the $1M that is invested will generate, and how much debt (if any) there is currently in the company.
If the company is currently entirely equity financed, then raising debt will reduce the WACC and therefore increase the value of the company (and hence the value of the equity). However the returns generated by the investment will also affect the value of the equity – if, for example, then returns are less that the interest payable on debt raised, then this will reduce the value of the equity.
There is not enough information to be able to provide a numerical answer.
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