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Question - CanStar Limited is an all equity firm, has 1,000,000 common shares outstanding and has earnings per share (EPS) of $3.00. Its tax rate is 25%. The company is considering making a $4 million investment which will increase EBIT by 20%. Its plan is to issue shares at their current market value of $20.
Required -
1. Assuming everything else remains the same, what is the expected share price? Show your work.
2. Now assume that CanStar would have to sell new stock at $18.50. Also assume that the underwriting spread is 5% and other direct financing expenses are $200,000. Based on this new information, what would be the expected share price?
3. Briefly explain the reasoning why the company's stock price might fall slightly when it announces the new equity offering?
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