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Chapter 5: 18BP_e (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.

e. Are the shareholders better off because of the sale of stock and the resultant investment? What other financing strategy could the company have tried to increase earnings per share?

Short Answer

Expert verified

The EPS has increased due to the investment made in the new facility and this has benefitted by the shareholders. The EPS can be increased by increasing the company’s earnings and also by buying-back the shares and reducing the outstanding shares.

Step by step solution

01

Impact of sale of stock and investment on shareholders

The investment made by the company due to the sale of shares has resulted in an increase in the earnings per share of the company. The increased EPS will benefit the shareholders as it will result in an increase in their earnings.

02

Financing strategy that the company could have used

The company can use the following financing strategy for increasing its EPS:

  1. Increasing the company’s net earnings: The increase in net earnings will also help in improving the company’s earnings per share.
  2. The buy-back of shares will help in reducing the number of outstanding shares which will result in an increase in company’s earnings per share.

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Most popular questions from this chapter

Kevin’s Bacon Company Inc. has earnings of \(9 million with 2,100,000 shares outstanding before a public distribution. Seven hundred thousand shares will be included in the sale, of which 400,000 are new corporate shares, and 300,000 are shares currently owned by Ann Fry, the founder and CEO. The 300,000 shares that Ann is selling are referred to as a secondary offering, and all proceeds will go to her.

The net price from the offering will be \)16.50, and the corporate proceeds are expected to produce $1.8 million in corporate earnings.

a. What were the corporation’s earnings per share before the offering?

b. What are the corporation’s earnings per share expected to be after the offering?

Do corporations rely more on external or internal funds as sources of financing?

What is a key tax characteristic associated with state and local (municipal) securities?

American Health Systems currently has 6,400,000 shares of stock outstanding and will report earnings of \(10 million in the current year. The company is considering the issuance of 1,700,000 additional shares that will net \)30 per share to the corporation.

a. What is the immediate dilution potential for this new stock issue?

b. Assume that American Health Systems can earn 9 percent on the proceeds of the stock issue in time to include them in the current year’s results. Calculate earnings per share. Should the new issue be undertaken based on earnings per share?

The Presley Corporation is about to go public. It currently has after-tax earnings of \(7,200,000, and 2,100,000 shares are owned by the present stockholders (the Presley family). The new public issue will represent 800,000 new shares. The new shares will be priced to the public at \)25 per share, with a 5 percent spread on the offering price. There will also be $260,000 in out-of-pocket costs to the corporation.

a. Compute the net proceeds to the Presley Corporation.
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