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F. Naz
F. Naz, B.Com
Category: Single Problem
Satisfied Customers: 5326
Experience:  Have completed B.Com and CA Finalist
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Consider an all-equity firm in a Modigliani-Miller world

Customer Question

Consider an all-equity firm in a Modigliani-Miller world with 500 shares outstanding and a cost of equity of rE = 0.15. Suppose that it has announced a dividend of 12 per share equal to its expected annual earnings. Suppose that the firm realizes lower
than expected of earnings of 3, 000, but does not expect this to impact its future cash flows. It does not want to reduce its dividend, and decides to issue new shares to make up the difference. How many new shares will be issued and at what price? What is
the payoff to existing shareholders?
Submitted: 2 years ago.
Category: Single Problem
Expert:  F. Naz replied 2 years ago.
Expected Market Price = 12/.15 = 80 per share is the issue price
New Shares to be issued = 3000/80 = 37.50 shares
Payoff = 15%.
Earnings per shre = 6000-3000/ 500 = $6 per share.
Customer: replied 2 years ago.
Isn't the price should be changed for those new shares?
Customer: replied 2 years ago.
i thought it should be np=3000 and 500p+3000=40000 p=74..the new price..
Expert:  F. Naz replied 2 years ago.
The formula for market price is dividend/Re = 12/.15 = 80