Chapter 5: 19BP_e (page 498)

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.
e. Determine what rate of return must be earned on the proceeds to the corporation so there will be a 5 percent increase in earnings per share during the year of going public.

Short Answer

Expert verified

The rate of return required is 17.29%.

Step by step solution

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After-tax earnings = $7,200,000

Shares outstanding = 2,100,000

Shares issued in new public issue = 800,000 shares

Selling price for new public issue = $25 per share

Spread = 5%

Out-of-pocket costs = $260,000

Net proceeds = $18,740,000

Calculation of net earnings required after stock issue to maintain before issue EPS

The net earnings required is $10.440,000.

$\begin{array}{rcl} EPS required & = & \frac{Net earnings}{Shares outstanding} + 5 % increase in EPS \\ = & \frac{$ 7, 200, 000}{2, 100, 000} + 5 % increase in EPS \\ = & $ 3.43 + 5 % increase in EPS \\ = & $ 3.60 \\ Net earnings & = & EPS \times Shares outstanding \\ = & $ 3.6 \times 2, 900, 000 \\ = & $ 10, 440, 000 \end{array}$

Calculation of additional earnings required

The additional earnings required is $3,240,000.

$\begin{array}{rcl} Additional earnings & = & Earnings required after stock issue - After tax earnings \\ = & $ 10, 440, 000 - $ 7, 200, 000 \\ = & $ 3, 240, 000 \end{array}$

Calculation of rate of return to be generated on the net proceeds

The rate of return required is 17.29%.

$\begin{array}{rcl} Rate of return & = & \frac{Additional earnings required}{Net proceeds} \\ = & \frac{$ 3, 240, 000}{$ 18, 740, 000} \\ = & 17.29 % \end{array}$

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Short Answer

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Calculation of net earnings required after stock issue to maintain before issue EPS

Calculation of additional earnings required

Calculation of rate of return to be generated on the net proceeds

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