Debt Overhang

[Mish]

Hi David,

I was reading the example on page 22 from Study Notes-T1-Foundations. Would you please tell me how to get 23.571 for Diluted Equity?

Thanks
Mish

 

[David Harper CFA FRM]

Hi Mish,

It's explained in Stulz, but the equity shareholders start with PV = $23.18. Then their undesirable choice is to invest $5 in order to grow their value only by $4.8 to $28.571. So existing shareholder would lose $0.24. They've lost (spend $5 to grow ~ $4.8) about $0.24; so "existing" shareholder are diluted from before $23.81 - 0.24 dilution = after $23.571.

Thanks,