Question
The Knight Corporation faces the need to raise external funds to undertake a new investment opportunity. By investing $100M, the project will generate $140M for
The Knight Corporation faces the need to raise external funds to undertake a new investment opportunity. By investing $100M, the project will generate $140M for sure in the next period and the market knows that. Thus, the NPV of the project is $40M. Unfortunately, Knight has no internal funds and, because of the nature of the business, has to raise funds by issuing equity. The problem is that the market does not know whether the current value of Knight assets is $100M or $20M, and regards both outcomes as equally likely. Assume that the discount rate is zero and Knight's managers are loyal agents of the existing shareholders.
a. If the market expects Knight to issue equity and undertake the investment independent of the true value of the company, what is the fraction of the company that new investors will ask for to invest $100M in the company?
Step by Step Solution
There are 3 Steps involved in it
Step: 1
![blur-text-image](https://dsd5zvtm8ll6.cloudfront.net/includes/images/document_product_info/blur-text-image.webp)
Get Instant Access with AI-Powered Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
![blur-text-image](https://dsd5zvtm8ll6.cloudfront.net/includes/images/document_product_info/blur-subtext-image.webp)
Step: 3
![blur-text-image](https://dsd5zvtm8ll6.cloudfront.net/includes/images/document_product_info/blur-subtext-image.webp)
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started