Financial Markets Dr. Cheol Park Why the stock price falls when seasoned equity is offered • Suppose the company currently has assets that is valued at $100M. • In addition to those assets in place , the company also has an investment project. Everyone knows that this company has such an investment project. The investment project costs $10M to start, and it will bring either $15M of cash in present value, or $20M of cash in present value. • Stock market participants currently believe that the two cash ﬂows are equally likely. If the company has currently 10M shares outstanding, then what is the current stock price? P = 100 M + (0 . 5)(5 M ) + (0 . 5)(10 M ) 10 M = $10 . 75 . • Now, suppose that the company’s manager knows which cash ﬂow will realize. This is the adverse selection problem . If he knows that the realized cash ﬂow will be $20M, would he issue new equity shares to ﬁnance the project? If he just does the rights issue, then, the share now is worth P = 100 M + 10
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