Stock price = $40 
Market value of firm = $400,000
Number of shares = 10,000 
Earnings per share = $4
Book net worth = $500,000 
Return on investment = 8%

Self has not performed spectacularly to date. However, it wishes to
issue new shares to obtain $80,000 to finance expansion into a
promising market. Self?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
EPS = $46,400/12,000 = $38.70

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.

Hi!!

To obtain the $80,000 they must issue 2,000 shares and sell them at
the market value ($40). Then the company's market value should
increase from $400,000 to $480,000, and this imply a market value of
$480,000/12,000 = $40 per-share as
before. But...
The value of Tobin's q for existing assets is:
q = market value / corporate net worth =
  = $400,000/$500,000 = 
  = 0.8
q is less than one, this means that the company is not going well and
partially reflects the poor image that the company has for the
analysts.
See "Tobin's-q":
http://en.wikipedia.org/wiki/Tobin's-q


If they continue making bad or poor invesments the market price will
decline. In effect if the injected $80,000 are invested in a manner
that the market values it similarly to the past investments, then its
market value will be:
Market Value = 0.8 * $80,000 = 
             = $64,000

Then the value of each share will be:
Stock value = Market value of stocks / # of stocks =
            = ($400,000 + $64,000) / (10,000 + 2,000) =
            = $464,000/12,000 = 
            = $38.67
The stock value found will fall from $40 to $38.67 since the financial
advisers have said!!
But we found the real reasons: it is not the sale of new shares what
depresses the stock's value, it is the poor investment of this money
in insufficiently profitable ventures which have made such job.
If they can do investments in a manner that the market values them
better, raising the Tobin's_q to a value greater than 1, then the
market price of the shares will raise.


I hope that this helps you. Feel free to request for a clarification
if you need it.

Regards,
livioflores-ga