“I was amazed to find that the announcement of a stock issue drives down the value of the issuing firm by 30%, on average, of the proceeds of the issue. That issue cost dwarfs the underwriter’s spread and the administrative costs of the issue. It makes common stock issues prohibitively expensive.”
a. You are contemplating a $100 million stock issue. On past evidence, you anticipate that announcement of this issue will drive down stock price by 3% and that the market value of your firm will fall by 30% of the amount to be raised. On the other hand, additional equity financing is required to fund an investment project that you believe has a positive NPV of $40 million. Should you proceed with the issue?
b. Is the fall in market value on announcement of a stock issue an issue cost in the same sense as an underwriter’s spread? Respond to the quote that begins this question.
Use your answer to (a) as a numerical example to explain your response to (b).
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