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Given data
Ke 16%(all equity company)
Market value (ex-div) $ 250 million
Existing number of shares 100,000
Constant dividend paid each ye $ 4 million
New investment requirement $ 1.5 million
NPV of project = $ 300,000 per annum in perpetuitySources to finance the new investment
1. Reduce existing dividend
2. Issue right shares 6,250 @ $ 240 each
3. Offer new public issueRequired: calculate value of company in each case separately?
Solution
1. Reduce dividend = (4,000,000+300,000)/16% = 26,875,000
= 26,875,000/100,000 = 268.752. Right shares = 26,875,000/(100,000+6,250) = 252.94
3. New offer = (26,875,000+1,500,000)/100,000 = 283.75
One thing is clear that value of the company will be increased by NPV of the project in each of above cases.
My first question is, Have I solved the question correctly ?
If yes then In second case where right shares are issued, why the inflow (of $1.5million) from right issue is not added to the market value of the company.Well……you have solved it correctly subject to two things.
Firstly, the NPV cannot be $300,000 per annum in perpetuity!!! What I think you mean is that the cash benefit from the project is $300,000 per annum in perpetuity.
Secondly, what you have calculated is the market value per share, which is not the value of the company (which is number of shares x mkt value per share).
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