Stock Dilution - Value Dilution

Value Dilution

Value dilution describes the reduction in the current price of a stock due to the increase in the number of shares. This generally occurs when shares are issued in exchange for the purchase of a business, and incremental income from the new business must be at least the Return on equity (ROE) of the old business. When the purchase price includes goodwill, this becomes a higher hurdle to clear.

The theoretical diluted price, i.e. the price after an increase in the number of shares, can be calculated as

Theoretical Diluted Price = ((O x OP) +(N x IP)) / (O + N) where

O = original number of shares

OP = Current share price

N = number of new shares to be issued

IP = issue price of new shares

For example if there is a 3-for-10 issue, the current price is $0.50, the issue price $0.32, we have

O = 10, OP = $0.50, N = 3, IP = $0.32 and TDP = ((10x0.50)+(3x0.32))/(10+3) = $0.4585

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