Explore BrainMass
Share

Explore BrainMass

    Pisa Construction: Evaluation of new issue of shares

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    Could someone please help me evaluate this argument with particular attention to the assumptions implicit in the numerical example?

    Here is recent financial data on Pisa Construction, Inc.

    Stock price $40 Market value of firm $400,000
    Number of shares 10,000 Earnings per share $4
    Book net worth $500,000 Return on investment 8%

    Pisa has not performed spectacularly to date. However, it wishes to issue new shares toobtain $80,000 to finance expansion into a promising market. Pisa's financial advisers think a stock issue is a poor choice because, among other reasons, "sale of stock at a price below book value per share can only depress the stock price and decrease shareholders' wealth." To prove the point they construct the following example: "Suppose 2,000 new shares are issued at $40 and the proceeds are invested. (Neglect issue costs.)

    Suppose return on investment does not change. Then
    Book net worth = $580,000
    Total earnings =.08(580,000) = $46,400

    Earnings per share 46,400 = $3.87
    12,000

    Thus, EPS declines, book value per share declines, and share price will decline proportionately to $38.70.

    © BrainMass Inc. brainmass.com April 1, 2020, 11:22 am ad1c9bdddf
    https://brainmass.com/business/accounting-for-corporations/pisa-construction-evaluation-of-new-issue-of-shares-42629

    Solution Preview

    Stock price $40
    Number of shares 10,000
    Earnings per share $4
    Market value of firm $400,000

    Return on investment= 10% =$4./$40.
    Return on investment should be calculated on market value and not on the book value
    Thus return on investment is 10% and not 8%

    Original investment = Mkt value of the ...

    Solution Summary

    The solutions evaluates the effect of new issue of shares on EPS, book value and share price

    $2.19