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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.