Reference no: EM133055956
A company must raise new capital externally to invest in a new project. The investment cost of the project is € 100 and the project generatesa certain cash flow of € 140. This information is known to the potential new external investors. The company has no internal financial resources to finance the project, and it can only raise new equity externally.
However, the potential new investors do not know whether the current asset value of the company(i.e., before investing in the new project) is € 100 or € 20 and estimate both possible values as equallylikely. The manager of the companyknows the true current asset value, but cannot make this information public for competitive reasons.
All participants are risk-neutral, the manager acts in the interest of the existing shareholders and the risk-free rate is zero.
Assume that potential new investors believe that the manager will raise new equity and invest in the new project, regardless of the true value of the existingassets.
-What share of the company value after investingin the project does the manager have to offer to the new externalinvestors so that they finance the investment cost of € 100?
-Assume that the currentasset value of the companyis € 100. Does the manager raise new equity?
-Assume that the currentasset value of the companyis € 20. Does the manager raise new equity?
Now assume that potential new investors believethat the managerwill raise new equity and invest in the new project, only if the true valueof the existing assets is € 20.
-What share of the company value after investingi in the project does the manager have to offerto the new external investors so that they finance the investment cost of € 100?
-Assume that the currentasset value of the companyis € 100. Does the manager raise new equity?
-Assume that the currentasset value of the companyis € 20. Does the manager raise new equity?
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