Chapter 5: 20BP_d (page 499)

Tyson Iron Works is about to go public. It currently has after-tax earnings of $4,400,000, and 4,200,000 shares are owned by the present stockholders. The new public issue will represent 500,000 new shares. The new shares will be priced to the public at $25 per share with a 3 percent spread on the offering price. There will also be $280,000 in out-of-pocket costs to the corporation.
d. Determine what rate of return must be earned on the net proceeds to the corporation so there will not be a dilution in earnings per share during the year of going public.

Short Answer

Expert verified

The rate of return required is 4.38%.

Step by step solution

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After-tax earnings = $4,400,000

Shares outstanding = 4,200,000

Shares issued in new public issue = 500,000 shares

Selling price for new public issue = $25 per share

Spread = 3%

Out-of-pocket costs = $280,000

Net proceeds = $11,845,000

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

The net earnings required is $4,920,900.

$\begin{array}{rcl} Net earnings & = & EPS \times Shares outstanding \\ = & $ 1.047 \times 4, 700, 000 \\ = & $ 4, 920, 900 \end{array}$

Calculation of additional earnings required

The additional earnings required is $520,900.

$\begin{array}{rcl} Additional earnings & = & Earnings required after stock issue - After tax earnings \\ = & $ 4, 920, 900 - $ 4, 400, 000 \\ = & $ 520, 900 \end{array}$

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

The rate of return required is 4.38%.

$\begin{array}{rcl} Rate of return & = & \frac{Additional earnings required}{Net proceeds} \\ = & \frac{$ 520, 900}{$ 11, 845, 000} \\ = & 4.38 % \end{array}$

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In \( millions	In \) millions
Current assets	\(70	Current liabilities	\)30
Fixed assets	\(70	Long-term liabilities	\)30
		Total liabilities	\(60
		Stockholder’s equity	\)80
Total assets	\(140	Total stockholder’s equity and liabilities	\)140

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 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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