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Chapter 5: 4BP (page 495)

Using the information in Problem 3, assume that American Health Systems’ 1,700,000 additional share can only be issued at $18 per share.

a. Assume that American Health Systems can earn 6 percent on the proceeds. Calculate earnings per share.

b. Should the new issue be undertaken based on earnings per share?

Short Answer

Expert verified

a. Earnings per share is $1.4612.

b. No, the new issue should not be undertaken.

Step by step solution

01

Computation of earnings per share

Newincome=ExpectedearningsAdditionalshares×valuepershare=6%1,700,000×$18=$1,836,000Totalincome=Newincome+Reportedearnings=$1,836,000+$10,000,000=$11,836,000NewEPS=TotalincomeOutstandingstock+Additionalissue=$11,836,0006,400,000+1,700,000=$1.4612

02

Undertaking of a new issue


EPSbeforestockissue=EarningsOutstandingstock=$10,000,0006,400,000=1.5625DecreaseinEPS=NewEPS-EPSbeforestockissue=$1.4612-$1.5625=-$0.1013

Conclusion: Hence, the new issue should not be undertaken because EPS will decrease by $0.1013.

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Most popular questions from this chapter

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.

b. Calculate the present value of total inflows.

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.

Tiger Golf Supplies has $25 million in earnings with 7 million shares outstanding. Its investment banker thinks the stock should trade at a P/E ratio of 31. Assume there is an underwriting spread of 7.8 percent. What should the price to the public be?

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.

c. What are the earnings per share (EPS) and the price-earnings ratio before the issue (based on a stock price of $48)? What will be the price per share immediately after the sale of stock if the P/E stays constant?

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