Here is recent financial data on Pisa Construction, Inc. Stock price$40Market value of f...

Here is recent financial data on Pisa Construction, Inc.

Pisa has not performed spectacularly to date. However, it wishes to issue new shares to obtain $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 = = $3.87

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

Evaluate this argument with particular attention to the assumptions implicit in the numerical example.