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Electronic Gaming Incorporated (EGI)is a firm with no debt and its 20 million shares are currently trading for $16 per share.Based on the prospects for EGI's new handheld video game,management feels the true value of the firm is $20 per share.Management believes that the share price will reflect this higher value after the video game is released next fall.EGI has already announced plans to raise $100 million from investors to build a new factory.
-Assume that EGI decides to raise the $100 million through the issuance of new shares prior to the release of the new video game.EGI's share price following the release of the new video game will be closest to:

Question

Quizplus · Accepted Answer

If EGI issues new shares to raise $100 million, then the total number of shares outstanding will increase. Assuming no change in the firm's value, the market price per share will decrease due to dilution. However, since management believes the true value of the firm is $20 per share, the new issuance will increase the overall value of the firm by $100 million / $20 per share = 5 million shares. Therefore, the total number of shares outstanding will be 20 million + 5 million = 25 million shares. The new share price will be:

New share price = Total value of the firm / Total number of shares outstanding
New share price = ($20 per share x 25 million shares) / 25 million shares
New share price = $20

Therefore, the share price following the release of the new video game will be $20 per share. However, this assumes that the new video game is successful and there are no other factors that affect the firm's value.

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