Question

Max Corp currently has 10 million shares on issue with a current stock price of $50.00 each. The major stockholder, I.M. Doingwell currently owns 60% of the shares. Max Corp then raises $200 million by issuing 5 million new shares to Doingwell. (a) What is the impact of the stock issue on the wealth of the other stockholders of Max Corp? (b) How would your answer change if the new shares were instead issued to a group of new investors rather than being issued to Doingwell ?

Answer 1

1. Total number of shares before issue= 10 Millions

Total number of shares that has been held by Mr.Doingwell=[60%×10 ]= 6 Millions

A)impact of new issue of shares to the overall capital structure will be addition of 5 million shares =[10+5]= 15 Millions.

Total number of shares of Mr. Doingwell after issue= (6+5)= 11 Millions

% of his total holdings=( 11/15)*100=73.33%

The impact of stock issue on the wealth of other stockholders will be not much because it is issued to an existing shareholder who is having the majority of the stake in the company and this kind of issue are usually RIGHTS ISSUES, so these are usually offered at a discount to the current market price as it has been happening in the same case as shares are issued at 40 ( 200/5),whereas the market price of the share is 50, so this will not be leading to much decrease in the price of other shareholders wealth as these are rights issue.

B) when did shares are issued to to another party then,

% of Mr Doing well stake=( 6/15)*100= 40%

In this case, it can be said that shares has been issued to another external party and these are not right issues so this will be leading to a decrease in the overall value of the existing shareholders stake because the shares have been issued at a lower price than the current market value and it would be leading to a decline of the share price because of issuance of the share price at a lower price than the current market price and it will be sending a bad signal to the entire market participants that company is not able to to charge the current market price from the new share holders as company value itself at 20% discount(50-40)/50)*100), than the current market price so it would be leading to adjustment of the shareholders stake to the current market price and it would mean the value of existing shareholders will go down.