Your firm has assets in place with value A which can be between 6 million and 12 million and is expected to stay constant in years 1 and 2. You know the value of A, but outside investors do not. In addition, your firm has 1 million of excess cash and the opportunity to invest 11 million in year 2 in a project that subsequently yields 13 million in year 3. Therefore, your firm needs to raise additional funds of 10 million in order to invest and realize the project's NPV. Your firm can repurchase (buy) or issue (sell) shares in years 1 and 2 before making the potential investment. Your objective is to maximize the firm value in year 3. You currently have 1 million shares outstanding. Assume no time discount. a) Assume that you can only issue shares in year 2, but cannot trade shares in year 1. Would you issue shares at a price of 8 if the value of your firm's existing assets A = 12 million? What if A = 6 million? [7 marks] b) Now assume that you can only repurchase shares in year 1, but cannot trade shares in year 2. Would you repurchase shares at a price of 10 if your firm's existing assets A = 12 million? What if A = 6 million? (Hint: you will not be able to issue equity for investment. Share repurchases reduce the firm's total number of shares) [7 marks] c) Finally, suppose you can repurchase shares at a price of 10 in year 1, as in part b). Subsequently, you can then issue equity at a price of 9 to finance the entire 11 million investment in year 2, should you still wish to pursue the project. If you directly issue equity for investment without a prior repurchase, the issue price is 8, same as in part a). What is the optimal choice for the firm if A = 12 million? What if A = 6 million? (Hint: there are four potential actions: repurchase and then issue, only repurchase, direct issue, and doing nothing.) [7 marks] d) Compare the firm's decision to repurchase equity when A= 6 million in part b) and part c). Is there a difference, and why? [4 marks] Your firm has assets in place with value A which can be between 6 million and 12 million and is expected to stay constant in years 1 and 2. You know the value of A, but outside investors do not. In addition, your firm has 1 million of excess cash and the opportunity to invest 11 million in year 2 in a project that subsequently yields 13 million in year 3. Therefore, your firm needs to raise additional funds of 10 million in order to invest and realize the project's NPV. Your firm can repurchase (buy) or issue (sell) shares in years 1 and 2 before making the potential investment. Your objective is to maximize the firm value in year 3. You currently have 1 million shares outstanding. Assume no time discount. a) Assume that you can only issue shares in year 2, but cannot trade shares in year 1. Would you issue shares at a price of 8 if the value of your firm's existing assets A = 12 million? What if A = 6 million? [7 marks] b) Now assume that you can only repurchase shares in year 1, but cannot trade shares in year 2. Would you repurchase shares at a price of 10 if your firm's existing assets A = 12 million? What if A = 6 million? (Hint: you will not be able to issue equity for investment. Share repurchases reduce the firm's total number of shares) [7 marks] c) Finally, suppose you can repurchase shares at a price of 10 in year 1, as in part b). Subsequently, you can then issue equity at a price of 9 to finance the entire 11 million investment in year 2, should you still wish to pursue the project. If you directly issue equity for investment without a prior repurchase, the issue price is 8, same as in part a). What is the optimal choice for the firm if A = 12 million? What if A = 6 million? (Hint: there are four potential actions: repurchase and then issue, only repurchase, direct issue, and doing nothing.) [7 marks] d) Compare the firm's decision to repurchase equity when A= 6 million in part b) and part c). Is there a difference, and why? [4 marks]
