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Stulz Chapter 3 - Debt Overhang

trabala38

Active Member
Hello !

While reviewing Stulz Chapter 3 - Debut Overhang, a concept does not seem clear to me : the computation of the "existing diluted equity value".

In the Excel file 2011.T1.a.2.xlx, the "Existing Equity DILUTED to $23,571". The computation behind is :

Existing Equity DILUTED = Value of Equity (without new project) - (5 - Increase in Equity Value)

My question concerns the input value $5. I guess it is related the the investment of $5 which will produce a cashflow of $10. But, it makes me wonder. Stulz states in his text "Since the new shareholders must receive $5 million worth of claims against the firm".

=> My question : how can shareholders have the "right" to claim $5million ? Also, the fact that the project is certain, thus, the fact that it will yield $10million of cashflow, makes me wonder why $5 was substracted instead of $10 (see the formula above)... Basically, I don't understand precisely how to segregate the old from the new shareholders.

Thanks a lot for your replies !

Regards,

trabala38
 
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