Chapter 5: 3BP (page 495)

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?

Short Answer

Expert verified

a. Immediate dilution is $0.328.

b. New EPS is $1.8012 and the new issue should be undertaken.

Step by step solution

Computation of immediate dilution

$E P S b e f o r e s t o c k i s s u e = \frac{E a r n i n g s}{O u t s \tan d i n g s t o c k} = \frac{$ 10, 000, 000}{6, 400, 000} = $ 1.5625 E P S a f t e r s t o c k i s s u e = \frac{E a r n i n g s}{O u t s \tan d i n g s t o c k + A d d i t i o n a l i s s u e} = \frac{$ 10, 000, 000}{6, 400, 000 + 1, 700, 000} = \frac{$ 10, 000, 000}{8, 100, 000} = $ 1.2345 D i l u t i o n = E P S b e f o r e s t o c k i s s u e - E P S a f t e r s t o c k i s s u e = $ 1.5625 - $ 1.2345 = $ 0.328$

Computation of New EPS

$N e w i n c o m e = E x p e c t e d e a r n i n g s (A d d i t i o n a l i s s u e \times p r i c e p e r s h a r e) = 9 % (1, 700, 000 \times $ 30) = 9 % (51, 000, 000) = $ 4, 590, 000 T o t a l i n c o m e = N e w i n c o m e + R e p o r t e d e a r n i n g s = $ 4, 590, 000 + $ 10, 000, 000 = $ 14, 590, 000 N e w E P S = \frac{T o t a l i n c o m e}{N u m b e r o f s h a r e s} = \frac{$ 14, 590, 000}{8, 100, 000} = $ 1.8012$

Undertaking of new issue

$G r o w t h i n E P S = N e w E P S - E P S b e f o r e s t o c k i s s u e = $ 1.8012 - $ 1.5625 = $ 0.2387$

The new issue should be undertaken because there will be no dilution and EPS will grow by $0.2387.

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Short Answer

Step by step solution

Computation of immediate dilution

Computation of New EPS

Undertaking of new issue

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