"Toy World" (TWD) is considering expanding into new geographic markets. The expansion will have the same business risk as TWD's existing assets. The expansion will require an initial investment of $50 million and is expected to generate perpetual EBIT of $20 million per year. After the initial investment, future capital expenditures are expected to equal depreciation, and no further additions to net working capital are anticipated. TWD's existing capital structure is composed of $500 million in equity and $300 million in debt (market values), with 10 million equity shares outstanding. The unlevered cost of capital is 10%, and TWD's debt is risk free with an interest rate of 4%. The corporate tax rate is 25%, and there are no personal taxes.
a. TWD initially proposes to fund the expansion by issuing equity. If investors were not expecting this expansion, and if they share TWD's view of the expansion's profitability, what will the share price be once the firm announces the expansion plan ($)?
b. Suppose investors think that the EBIT from TWD's expansion will be only $4 million. What will the share price be in this case? ($)?
c. How many shares will the firm need to issue in the case of item (b)?