Need Help Please:

Here is some recent financial data on a company:
Stock Price $40
Number of Shares 10,000
Book net worth $500,000
Market Value of firm $400,000
Earnings Per share $4
Return on investment 8%

This company has not performed spectatular to date. However, it wishes
to issue new shares to obtain $80,000 to finance expansion into a
promising market. The finacial advisors 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
share-holders 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..

Please help!

Hi!!

To obtain the $80,000 for financing the new expansion the company must
issue 2,000 shares and sell them at the market value of $40 (ignoring
the issuing costs).
This injection of new money makes increase the company's market value
from $400,000 to $480,000, and this imply a market value of
$480,000/12,000 = $40 per-share as before.
Until this its all right, but there are storm cluds on the horizon:
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 has not performed
spectatular to date 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 the bad performance, means they do a poor invesment
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,
then its market value will be:
Market Value = 0.8 * $80,000 = 
             = $64,000

Therefore the per-share value will be:
Stock value = Total 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 isn't the issue 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, that would
raise the market price of the shares.


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

Best regards,
livioflores-ga