Prior to equity financing:

Market Capitalization is $1B

Current Share price: $50.00

Total Common Shares outstanding: 20,000,000

The company wants to raise 100M in equity through stock selling. I want to know how each of these numbers are effected.

These are not the numbers to a specific problem, I just want to learn how each number changes.


In an ideal world the company would issue 2M extra shares priced at 50. The number of shares would go to 22M and the market cap would be 1.1 Billion. This implicitly assumes the company would invest the money wisely in expanding its business at similar rates of profit, all relevant information is publicly available, etc.

In the real world the equity market is somewhat cynical about new equity issues. Shareholders are likely to ask: is the company in trouble? What do they need the money for? Why now when they said at the last AGM that they would not need new money for the foreseeable future (do they know something we don't)? Why didn't they issue debt instead? (Is company in trouble with the banks?) Will they squander some of the money on extra bonuses? For this reason the equity announcement is taken as "bad news" and empirical studies show a drop of 2 to 3% in the equity price upon announcement. The investment bankers will likely recommend a price of 49 a shares and the issue of 2.04 million shares. They will tell new investors this price is attractive for a company that was quoted at 50, thus making their job easier. Of course the shares are fungible so all shares will go to 49 and the number of shares to 22.04M.

This is in the short run. In the long run it all depends how well the new money is used, doesn't it? So one should not be too pessimistic about the short run price drop, it will probably matter little in the end. It is just a small bump in the road, the cost of doing business in a world of financial frictions and imperfect information.


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