PART SIX Cost of Capital and Long-Term Financial Policy

3. Issue costs. As we discuss next, there are substantial costs associated with selling securities.

The drop in value of the existing stock following the announcement of a new issue is an example of an indirect cost of selling securities. This drop might typically be on the order of 3 percent for an industrial corporation (and somewhat smaller for a public utility), so, for a large company, it can represent a substantial amount of money. We label this drop the abnormal return in our discussion of the costs of new issues that follows.

To give a couple of recent examples, in July 2001, Charles River Laboratory announced a seasoned equity issue of $232 million. Its stock fell 8.1 percent on the day. Similarly, when Overseas Shipbuilding announced an offering in June of 2001, its stock dropped by 9.9 percent. Note that, in both cases, the stock decline is larger than is typical.

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