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Chapter 5: 18BP_a (page 498)

Midland Corporation has a net income of \(19 million and 4 million shares outstanding. Its common stock is currently selling for \)48 per share. Midland plans to sell common stock to set up a major new production facility with a net cost of \(21,120,000. The production facility will not produce a profit for one year, and then it is expected to earn a 13 percent return on the investment. Stanley Morgan and Co., an investment banking firm, plans to sell the issue to the public for \)44 per share with a spread of 4 percent.

a. How many shares of stock must be sold to net $21,120,000? (Note: No out-of-pocket costs must be considered in this problem.)

Short Answer

Expert verified

The company should sell 500,000 shares to get $21,120,000.

Step by step solution

01

Information provided in the question

Net income = $19,000,000

Shares outstanding = $4,000,000

Present selling price = $48 per share

ROI =13 %

Selling price for public issue = $44 per share

Spread = 4%

02

Calculation of the number of shares to be sold

The company should sell 500,000 shares.

Numberofshares=NetamountrequiredShareprice×1-Flotationcost=$21,120,000$44×1-4%=500,000shares

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Most popular questions from this chapter

Discuss how an underwriting syndicate decreases risk for each underwriter and at the same time facilitates the distribution process.

Question: Barton Simpson, the chief financial officer of Broadband Inc. could hardly believe the change in interest rates that had taken place over the last few months. The interest rate on A2 rated bonds was now 6 percent. The $30 million, 15-year bond issue that his firm has outstanding was initially issued at 9 percent five years ago. Because interest rates had gone down so much, he was considering refunding the bond issue. The old issue had a call premium of 8 percent. The underwriting cost on the old issue had been 3 percent of par, and on the new issue it would be 5 percent of par. The tax rate would be 30 percent and a 4 percent discount rate would be applied for the refunding decision. The new bond would have a 10-year life. Before Barton used the 8 percent call provision to reacquire the old bonds, he wanted to make sure he could not buy them back cheaper in the open market.

d. In terms of the refunding decision, how should Barton be influenced if he thinks interest rates might go down even more?

Discuss the reason for the differences between underwriting spreads for stocks and bonds.

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Question: Barton Simpson, the chief financial officer of Broadband Inc. could hardly believe the change in interest rates that had taken place over the last few months. The interest rate on A2 rated bonds was now 6 percent. The $30 million, 15-year bond issue that his firm has outstanding was initially issued at 9 percent five years ago. Because interest rates had gone down so much, he was considering refunding the bond issue. The old issue had a call premium of 8 percent. The underwriting cost on the old issue had been 3 percent of par, and on the new issue it would be 5 percent of par. The tax rate would be 30 percent and a 4 percent discount rate would be applied for the refunding decision. The new bond would have a 10-year life. Before Barton used the 8 percent call provision to reacquire the old bonds, he wanted to make sure he could not buy them back cheaper in the open market.

c. Now do the standard bond refunding analysis as discussed in this chapter. Is the refunding financially feasible?
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