Here is recent financial data on J and L,Inc.
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 2% quarterly.
J and L,Inc. has not performed spectacularly to date. However, it
wishes to issue new shares to obtain $100,000 to finance expansion
into a promising market. Pisa?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 2,500 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 = $600,000
Total earnings = .0824(600,000) = $49,440
Thus, EPS declines, book value per share declines, and share price
will decline proportionately
to $38.40.?
Evaluate this argument with particular attention to the assumptions
implicit in the numerical example. |
Clarification of Question by
sophisticated1-ga
on
10 Oct 2006 14:52 PDT
Here is recent financial data on J and L Construction, Inc.
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 2% quarterly.
J and L has not performed spectacularly to date. However, it wishes to
issue new shares to
obtain $100,000 to finance expansion into a promising market. J and L
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
2,500 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 = $600,000
Total earnings = .0824(600,000) = $49,440
Thus, EPS declines, book value per share declines, and share price
will decline proportionately
to $38.40.?
Evaluate this argument with particular attention to the assumptions
implicit in the numerical example.
If feedback could be posted within 24 hours that would be fantastic!
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