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Financing Decision

The current stock price of Next airlines is $40. If Next issues equity, Next's management anticipates that the market will react negatively and that Next will only be able to sell the new shares for $35 per share. However, Next airlines management knows that if they do not issue equity their stock will soon go up to its fair fundamental value of $50 per share. Management knows this because they have inside information that future earnings will be higher than the market expects. Currently Next has 100,000 shares outstanding. Next is considering investing in a new airplane that will cost them $350,000. They anticipate that the present discounted value of increased earnings from purchasing the new plane is $450,000.
If Next had the cash available to purchase the new plane, should it make the purchase? If Next needs to finance the purchase of the new plane with equity, will it make sense for them to purchase the plane?

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The current stock price of Next airlines is $40. If Next issues equity, Next's management anticipates that the market will react negatively and that Next will only be able to sell the new shares for $35 per share. However, Next airlines management knows that if they do not issue equity their stock will soon go up to its fair fundamental value of $50 per share. Management knows this because they have inside information that future earnings will be higher than the market expects. Currently Next has 100,000 shares outstanding. Next is considering investing in a new airplane that will cost them $350,000. They anticipate that the present discounted value of increased earnings from purchasing the new plane is $450,000.

If Next had the cash available to purchase the new plane, should it make the purchase? If Next needs to finance the purchase of the new plane with equity, will it make sense for them to purchase the plane?

If Next had the cash ...

Solution Summary

The solution discusses whether the new plane should be purchased by available cash or by issue of equity.

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