Question

Kahuku Corporation has 100 million shares outstanding trading at $20 per share. The company announces its intention to raise $150 million by selling new shares.

a. What do market signaling studies suggest will happen to Kahuku’s stock price on the announcement date? Why?

b. How large a gain or loss in aggregate dollar terms do market signaling studies suggest existing Kahuku shareholders will experience on the announcement date?

c. What percentage of the value of Kahuku’s existing equity prior to the announcement is this expected gain or loss?

d. At what price should Kahuku expect its existing shares to sell immediately after the announcement?

Answer 1

a) Market signalling studies suggest there will be a decrease in value of share price. This decrease is based on the assumption that there is no expansion in the business and revenue and net income will remain the same. However, the net income will now be distributed to greater number of shareholder hence the share price will decrease.

b) Existing market Capitalisation = 100 million * $20 = $2,000 Million

New issue of shares = $ 150 Million / $20 = 7.5 Million Shares

No. of shares after raising monies = 100 Million existing + 7.5 Million new shares = 107.5 Million Shares

As explained in part a), assuming no expansion, the value (Market Capitalisation) of the company remains same and will be divided by the increase no. of shares.

Share Price after announcement = $2000 Million / 107.5 Million = $ 18.60 per share

Percentage Loss = (20 - 18.60) / 20 *100 = 7% Loss

c) $150 Million * 7% / $ 2000 Million = $ 10.5 Million / $ 2000 Million = 0.525%

d) The price would drop to $18.60 per share after the announcement.