Hi All, I got the following questions in a finance exam. However, i get confused in answering them. ==================================================== All equity and no debt in the company’s capital structure; outstanding shares = 1,000,000 share price = $10 cost of capital = 15% Project A: Investment cost = $5,000,000; PV of future cash flow = $6,500,000 Discount rate = 15% 1. How many new shares should be issued to fund the investment? 2. How would the firm value change when taking Project A? 3. How would the share price change when taking Project A? ==================================================== My question is , do i really need to issue new shares to fund the project? Can i assume the company can use internal fundings (eg. retained earning) for the project? Thanks.
Your question is a bit naive. You need to review accounting 101 to understand that RE is not a bucket of cash.
My question is , do i really need to issue new shares to fund the project? Can i assume the company can use internal fundings (eg. retained earning) for the project? ----------------- but the cost of capital is 15%. therefore for the company to sit on internal cash (working capital), it’s opportunity cost is 15%. given the info above, it’s leading you to issue shares b/c you would bank $1.5MM by pursuing the project. If you want to be a smarta$$ and get the question wrong, the probably more appropriate way to pursue this project is to issue debt to fund this. however, you are assuming cost of debt is less then cost of equity, which better always be the case, otherwise capital structure arbitrage is present.