Download Case Study: Buying and Selling Shares of Alanna

Reproducible Sheets
Case Study: Buying and Selling Shares of Alanna
Corporation
Alanna Corporation is a large manufacturer of
computer games and other software. The table below
shows the number of buy and sell orders for this
hypothetical firm’s shares currently available on the
stock exchange. Note that at the price of $30.00, while
100,000 shares are being offered for sale, only 10,000
shares are being requested by buyers. Conversely, at
the reduced price of $15.00, 100,000 shares are being
requested, but only 10,000 shares are available.
Current market conditions will not permit either of
these prices. Only at the price of $22.50 per share will
there will be an equal quantity of buy and sell orders.
As market forces prevail, the price of Alanna
Corporation shares will be $22.50, and the quantity
transacted will be 45,000 shares. Both buyers and
sellers must pay their brokers a small commission for
completing the transaction as ordered.
In graph A, continuous curves have been drawn
through the points of the demand and supply
schedules. The point of intersection E1 confirms that
45,000 shares will be transacted at a price of $22.50
per share.
The next day Alanna Corporation reports that
earnings for the present business quarter (the last three
months) will be 10 per cent higher than forecasted
because of increased sales. As a result of this positive
announcement, share buyers’ interest increases
because of the potential for increased dividends and
share prices. In addition, shareholders are more
reluctant to sell given the positive news. As a result,
the demand for shares increases while the supply
RS 6-4
decreases. In graph A, the new demand curve for
Alanna Corp. shares reflects an increase of 15 000
shares at each price. The new supply curve reflects a
decrease of 15,000 shares at each price. Shifts in the
two curves result in a new point of equilibrium (E2).
While the quantity transacted remains at 45,000
shares, the market price has increased to $25 per share.
© Oxford University Press (Canada) 2003. Permission to reproduce for classroom use restricted to schools purchasing Economics Now.
Reproducible Sheets
Case Study: Buying and Selling Shares of Alanna
Corporation (continued)
RS 6-4
Let’s now assume that Alanna Corporation needs to
raise $600,000 to purchase a computerized inventorymanagement system in order to increase efficiency. If
the company decides to borrow the money from a bank
instead of issuing new shares, then the company’s
liabilities (debts) will increase, causing the asset value
of all shares to decrease. With share prices usually in
the $20.00 range, the firm could sell approximately 30
000 new shares in order to raise the required money
capital. By offering the additional shares for sale, the
corporation has increased the supply curve by 30,000
shares at each price. Graph B shows that the new point
of equilibrium (E3) would involve the transaction of
60,000 shares (30.000 new shares issued by the
corporation and 30 000 shares sold by current holders)
at a price of $22.50 per share.
Questions
1. In Graph A, the decrease in supply is equal to the increase in demand. The result is an increase in
price with no change in the quantity transacted. Draw a graph to explain the effect on market price and
quantity transacted if the demand increases by 15,000 at each price level while the supply decreases by
30,000 at each price level.
2. Graph B shows that the corporation has issued 30,000 new shares. Draw a graph to explain the effect
on market price and quantity transacted if the corporation had issued and sold 60,000 new shares.
3. Draw a graph to illustrate and explain the effect on market price and quantity transacted if the
corporation had reported that earnings were going to be 10 per cent less than forecasted.
4. Explain the effect of a $600,000 bank loan on the asset value of corporation shares. Explain the
effect on the asset value if all the funds raised by selling new shares are used to acquire additional
capital equipment owned by the corporation.
© Oxford University Press (Canada) 2003. Permission to reproduce for classroom use restricted to schools purchasing Economics Now.