Question

Discuss the three plausible reasons why stock prices tend to decline following the announcement of a new equity issue, but tend to rise following a debt announcement.     

Answer 1

Three possible reasons why stock prices tend to decline following the announcement of a new equity issue, but tend to rise following a debt announcement are
1.When new shares are issued the number of outstanding shares increases and hence market reacts by lowering of price as ownership percentage of existing shareholder decreases. Debt increases the value of the firm hence it increases the share price of firm

2. New Shares lowers the EPS as Earnings remain same but number of shares decreases. This decreases the stock price. Issuing of Debt provides benefit of interest tax shield hence it increases the share price.

3. Issuing new shares through increases the cost of capital of firm , hence it decreases intrinsic value of firm and hence share price falls. Issuing debt decreases cost of capital and reduces the number of outstanding shares. This increase the share price.