Reference no: EM133045624

Question - A manager believes the stock of her firm is worth $1500m with no knowledge of any new projects.

The manager believes her stock is fairly valued with 100m shares outstanding priced at $15 a share before considering any new projects.

The firm also has debt with a market value of $800m rated AAA and the firm pays no taxes (for simplicity). There is virtually no chance of a bond default.

The manager wants to take a project with present value of future cash flows = $500m, with an upfront cost of $450 million. This project was unknown to market participants and management until just now. If not taken now, the project goes away.

The manager wants to issue stock to fund the deal, but market participants are leery. They believe that the manager would only issue stock if the firm is overvalued. If stock is offered, they will only pay $14.25 per share. Assume that an underwriter will take 4% of any stock sale at $14.25 per share and the firm will get what is left over ($14.25 x .96)) = $13.68 after fees.

a) How many shares of stock will the firm have to issue to fund the project? Allow fractional shares.

b) Will the manager still want to fund the project as stated given the parameters of an equity issue discussed above? Why or why not?

c) Could there possibly be a better way to finance the project that gets a better outcome?

d) If the debt of the firm is rated B+ (a junk bond with decent default odds) and trades at a discount to initial offering value, could the existence of this debt alter your answer in part b)? Why?