Chapter 5: 18BP_d (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.
d. Compute the EPS and the price (P/E stays constant) after the new production facility begins to produce a profit.

Short Answer

Expert verified

The EPS is $4.83 and the stock price is $48.83 after the new facility starts generating profit.

Step by step solution

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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%

EPS = 10.1 times

Calculation of earnings of the company from the new facility

The earnings from the new facility is $2,745,600.

$\begin{array}{rcl} Additional income & = & ROI \times Cost of new facility \\ = & 13 % \times $ 21, 120, 000 \\ = & $ 2, 745, 600 \end{array}$

Calculation of EPS after the new facility starts generating profit

The earnings per share is $4.83.

$\begin{array}{rcl} EPS & = & \frac{Earnings}{Stock Outstanding} \\ = & \frac{$ 19, 000, 000 + $ 2, 745, 600}{4, 000, 000 + 500, 000} \\ = & $ 4.83 \end{array}$

Calculation of stock price of the company after new facility starts generating profit

The stock price is $48.83.

$\begin{array}{rcl} Price per share & = & PE \times Earnings per share \\ = & 10.1 \times $ 4.83 \\ = & $ 48.83 \end{array}$

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Bailey corporation
Income statement
For the year 20X1
Sales (all on credit)	\(42,680,000
Cost of goods sold	\)32,240,000
Gross profit	\(10,440,000
Selling and administrative expenses	\)4,558,000
Operating profit	\(5,882,000
Interest expense	\)600,000
Net income before taxes	\(5,282,000
Taxes	\)2,120,000
Net income	\(3,162,000

Bailey corporation
Balance sheet
As of December 31, 20X1
Assets
Current assets:
Cash	\)250,000
Marketable securities	\(130,000
Accounts receivables	\)6,000,000
Inventory	\(8,300,000
Total current assets	\)14,680,000
Net plant and equipment	\(13,970,000
Total assets	\)28,650,000
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	\(3,800,000
Notes payable	\)3,550,000
Total current liabilities	\(7,350,000
Long-term liabilities	\)5,620,000
Total liabilities	\(12,970,000
Stockholder’s equity:
Common stock (1,800,000 shares at \)1 par)	\(1,800,000
Capital in excess of par	\)6,300,000
Retained earnings	\(7,580,000
Total stockholder’s equity	\)15,680,000
Total liabilities and stockholder’s equity	\(28,650,000

Short Answer

Step by step solution

Information available

Calculation of earnings of the company from the new facility

Calculation of EPS after the new facility starts generating profit

Calculation of stock price of the company after new facility starts generating profit

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