PARIS - Auto maker PSA Peugeot Citroën SA will issue as many as 120.8 million new shares at a 42 percent discount from Monday's average share price, under terms of the company's capital increase of €1 billion ($1.32 billion).

The share sale includes an about €240 million investment by General Motors Co. for a 7 percent stake to cement their joint development and procurement alliance. Peugeot also said its financing arm, Banque PSA Finance, applied for €700 million in low-interest loans from the European Central Bank's refinancing operation at the end of February, reported The Wall Street Journal.

"The capital increase is entirely designed to finance Peugeot's strategic project with GM and will allow it to pursue its global expansion strategy and its plan to move its model range upmarket," Chief Financial Officer Jean-Baptiste de Chatillon said on Tuesday.

Peugeot's offer—giving shareholders the right to purchase 16 new shares for every 31 existing shares—will be open between March 8 and March 21, the company said. The family-controlled company said it won't pay a 2011 dividend to bolster its finances.

Peugeot's shares were down 3.5 percent at €13.71 in Paris on Tuesday, with some analysts warning of the significant dilution shareholders face from the capital increase and lack of a dividend. Peugeot and GM have also acknowledged slim initial financial benefits from the alliance even if annual cost savings could reach $2 billion a year in five years.

"Bottom line: such a dilution for the prospect of a long-dated payoff fuels our recommendation to sell the rights," analysts at Barclays Capital said.

Mr. De Chatillon said the share price decline wasn't surprising. "It's true the share price has gone down a bit, but that's normal in capital increases because of the dilution effect," he said. "The news of the dividend [suspension] wasn't expected by the market," he added.

Peugeot and GM said they are seeking to address the problem of surplus capacity in Europe.

"We will deal with the overcapacity issue by 2014 notably in France and Spain where the overcapacity is most acute," said Denis Martin, the head of Peugeot's industrial operations. "We've already had a certain number of meetings with labor representatives in Europe and have put the overcapacity issue on the table," Mr. Martin said.

GM Vice Chairman Stephen Girsky said on Tuesday that the U.S. auto maker also is in the middle of talks with unions about a fresh round of cost cuts.

"We're trying to change the calculus here," Mr. Girsky said. "This company has lost a lot of money [in Europe], and we know that running the same play the way we've been running it won't work."

The two auto makers expect each will generate significant cost savings at their struggling European car operations through their five-year alliance. The alliance will include sharing of vehicle architectures, components and the creation of a global procurement joint venture. Combined purchases will be about $125 billion a year, the companies said. They plan to build some vehicles together as soon as 2016.

Paris-based Peugeot is to become GM's main partner in Europe and the two may consider broadening the partnership to other regions. They will continue to operate as separate companies and compete with each other in many markets. Longer term, the arrangement could lay the groundwork for a deeper partnership between the two.

But the deal isn't an antidote to the companies' financial troubles in Europe, which has GM undertaking a major restructuring in addition to Peugeot's capital increase. Both companies have ruled out any deep changes to their operations in the short term while analysts have cautioned that the alliance doesn't address the problem of chronic overcapacity, estimated at 20 percent or more, in Europe's car industry.

Auto sales in Western Europe are down 14 percent since 2007. But in that time, among major auto makers, only GM and Fiat have closed a factory, one apiece. Matching production to sales would require eliminating 1.5 million vehicles worth of annual production capacity—the equivalent of five assembly plants, estimates Morgan Stanley.

The investment in Peugeot and cost-saving alliance is GM's most significant manufacturing alliance since its 2009 bankruptcy. The auto maker has tried European partnerships in the past with mixed results. GM paid $2 billion to Fiat in 2005 to dissolve a failed alliance.

Following the rights issue, General Motors will hold 7 percent in Peugeot Citroën and the Peugeot family will remain the main shareholder, with 25.3 percent of capital and 37.9 percent of the voting rights.

Société Générale SA, BNP Paribas SA and Morgan Stanley are arranging the rights issue.