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CanStar Limited is an all equity firm, has 1,000,000 common shares outstanding and has earnings per...

CanStar Limited is an all equity firm, has 1,000,000 common shares outstanding and has earnings per share (EPS) of $3.00. Its tax rate is 25%. The company is considering making a $4 million investment which will increase EBIT by 20%. Its plan is to issue shares at their current market value of $20.

a) Assuming everything else remains the same, what is the expected share price? Show your work.

b) Now assume that CanStar would have to sell new stock at $18.50. Also assume that the underwriting spread is 5% and other direct financing expenses are $200,000. Based on this new information, what would be the expected share price?

c) Briefly explain the reasoning why the company’s stock price might fall slightly when it announces the new equity offering?

Solutions

Expert Solution

Can star has 1000000 share outstanding and eps of $ 3 per share

Total earnings available to shareholdere = 3000000

Tax rate = 25%

EBIT = earnings /(1-tax)

= 3000000/.75

=4000000

Current market value =20$/share

P/E ratio =market value /eps

=20/3= 6.67 time

Company consider to making investment of 4 million which will increase EBIT by 20%

New earnings =4000000*1.2

New EBIT = 4800000$

Tax @25% =1200000

New eaes =3600000

No of share =1000000+(4000000/20)(new issues)

=1200000

Eps =eaes/no of share

=360000/12

= 3$/share

New price = Eps *pe ratio

=3*3.67

=20/sh

B ,new price is 18.5 share and underwriter spred 5% so net proceeds per share= (18.5*.95)=17.575

Total amount required = 4000000+200000(financing expenditure)

Additional equity to be issued =4200000/17.575

=239017

Total equity =1000000+239017

=1239017$

Eaes was 3600000 - fianace expense net of tax

=3600000 -150000-152500

=3297500

New ePS =3297500/1293017

=2.66$/share

Value of share = 2.66*6.67

=17.74 $/share

C) company share price fall slightly on announcement of new issues because due to flow of new share supply of share increase while demand isn't increase in that respect. Further if company announced new issues shareholders expectations increase and if expectations increase value decrease.

jeff jeffy answered 2 years ago
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