Here is recent financial data on Pisa Construction, Inc.
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Pisa has not performed spectacularly to date. However, it wishes to issue new shares to obtain $80,000 to finance expansion into a promising market. Pisa’s financial advisers think a stock issue is a poor choice because, among other reasons, “sale of stock at a price below book value per share can only depress the stock price and decrease shareholders’ wealth.” To prove the point they construct the following example: “Suppose
2,000 new shares are issued at $40 and the proceeds are invested. (Neglect issue costs.)
Suppose return on investment doesn’t change. Then
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Thus, EPS declines, book value per share declines, and share price will decline proportionately to $38.70.”
Evaluate this argument with particular attention to the assumptions implicit in the numerical example.
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