Consider a firm where insiders know that the firm has assets worth $100 million. The firm has 1 million shares outstanding and no debt, implying that the shares have an intrinsic value of $100 per share without taking any new investments1. Suppose the firm gets an investment opportunity that costs $70 million and whose cash flows have an expected present discounted value of $90 million.

Despite insiders knowledge about the value of the assets, the firms shares are trading at $70 per share. The firms investment banking advisors have told the management of the firm that if they wish to issue more shares for any purpose, the market will still only give it $70 per share for each new share issued. Management has no way of revealing the intrinsic value of the firm to the market, but it expects the market value of its shares to converge eventually to their intrinsic value.

a) How many shares would the firm have to issue at $70 per share to invest in the project?

b) After the firm has undertaken the project, what is the true new value of the firms assets as known by insiders?

c) What is the new intrinsic value per share if the firm raises the proceeds for the project by issuing shares?

d) If acting in the interest of existing shareholders, should management take the project?