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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

01

Information available

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

02

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

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

Netearnings=EPS×Sharesoutstanding=$1.047×4,700,000=$4,920,900

03

Calculation of additional earnings required

The additional earnings required is $520,900.

Additionalearnings=Earningsrequiredafterstockissue-Aftertaxearnings=$4,920,900-$4,400,000=$520,900

04

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

The rate of return required is 4.38%.

Rateofreturn=AdditionalearningsrequiredNetproceeds=$520,900$11,845,000=4.38%

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Most popular questions from this chapter

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.

b. Compute the earnings per share immediately before the stock issue.

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.

e. Determine what rate of return must be earned on the proceeds to the corporation so there will be a 10 percent increase in earnings per share during the year of going public.

Question: The Bowman Corporation has a \(18 million bond obligation outstanding, which it is considering refunding. Though the bonds were initially issued at 10 percent, the interest rates on similar issues have declined to 8.5 percent. The bonds were originally issued for 20 years and have 10 years remaining. The new issue would be for 10 years. There is a 9 percent call premium on the old issue. The underwriting cost on the new \)18,000,000 issue is \(530,000, and the underwriting cost on the old issue was \)380,000. The company is in a 35 percent tax bracket, and it will use an 8 percent discount rate (rounded after-tax cost of debt) to analyze the refunding decision.

d. Should the old issue be refunded with new debt?

How does the bond rating affect the interest rate paid by a corporation on its bonds?

What is the purpose of serial repayments and sinking funds? (LO16-1)
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