Question

1. According to Signaling theory, why does the stock price decline when a new stock offering is announced?

2. According to Modigliani and Miller theory, what happens to the value of a company when additional debt is issued? (assume corporate taxes exist)

3. With an optimal capital structure, what is maximized and what is minimized?

4. According to Windows of Opportunity theory, when will a company issue stock?

Answer 1

1.According to Signaling theory, why does the stock price decline when a new stock offering is announced?

solu: This is known as stock dilution, when additional stock is offered the value per share/stock decreases depending upon the quantum of addition.

2. According to Modigliani and Miller theory, what happens to the value of a company when additional debt is issued? (assume corporate taxes exist)

Solu: MM theory states that, the value of the firm is not dependent on its capital structure, but depends on its operating income apart from the risk involved in the investment.

When corporate taxes does not exist:

1) value of the firm remains the same though additional debt is issued

  When corporate taxes does exist:

1) cost of debt reduces by interest tax benefits

2) The value of the firm changes depending upon the debt component

3.With an optimal capital structure, what is maximized and what is minimized?

solun: As we know optimal capital structure is determined by calculating the mix of debt & equity or Quantum of it.

a) optimal capital structure maximizes - market value of the company (shareholders wealth)

b) optimal capital structure minimizes - WACC ( weighted average cost of capital)  

4. According to Windows of Opportunity theory, when will a company issue stock

Solu: When large amount of capital is required.