Doubts

Mock - Exercise 2c

Mock - Exercise 2c

by Alois Jari Thomas Neff -
Number of replies: 2

Hi Julio,

I realize there have already been several questions about this task, but I’d like to ask for some clarification once more.

The task specifically states: “What is the realized return of the stock after the issuance announcement?” — not after the actual issuance of debt or the execution of the share buyback.

Given that, my understanding is as follows:

  • The number of shares should remain at 0.5 million.

  • Based on the video lecture slides, following the announcement of a positive NPV project, only the value of the NPV (in this case, €1 million) is added to the firm value. The stock price adjusts accordingly.

  • Therefore, the new equity value becomes €11 million after the announcement, implying a stock price of €22 (€11M / 0.5M shares), which results in a 10% return ((22 – 20) / 20).

My question is: Why are we already accounting for the share buyback (reducing shares to 0.45 million and equity to €10 million) immediately after the announcement, even though the debt issuance and buyback haven't yet occurred? Using the adjusted figures (€10M / 0.45M shares), the stock price would be €22.22, which implies a return of only 11.11% (what seems like the right solution according to your slides).

Also for 3d: Why do we multiply the resulting stock price of €24, which reflects a 20% return, by the number of shares after the buyback (0.45 million) to arrive at an equity value of €10.8 million, leading to a PV(ITS) of €0.8 million? Shouldn’t we still be using the original number of shares (0.5 million), since we are only at the announcement date, and the buyback hasn’t been executed yet?

Thanks again for your help!

In reply to Alois Jari Thomas Neff

Re: Mock - Exercise 2c

by Julio Crego -
The value increases by NPV + Initial investment

Note that the increase in value is not due to the buyback but to the new project. Therefore, only the expectation of receiving those payoffs is enough
In reply to Julio Crego

Re: Mock - Exercise 2c

by Alois Jari Thomas Neff -
I understand that the total firm value increases by the NPV of the project plus the initial investment. However, for question 2c, we need the equity value after the announcement in order to determine the new share price and the resulting return after the announcement.

What I don’t fully understand is why the calculation for the new share price already assumes that the share buyback has occurred, even though only the project announcement has been made. According to the lecture slides of topic 8a, only the NPV of the project is added to the firm value at the time of the announcement. The other steps, such as the €1M investment on the asset side, the €2M in new debt, and the €1M equity reduction due to the buyback on the passive side, are implemented later.

So my question is:
If the task states that “the project has been announced but not yet implemented,” should we already factor in all subsequent steps (i.e., the debt issuance and the share buyback) when calculating the new share price?

Thank you very much!