Chapter 5: Q15-1CP_d. (page 500)

Question: The Bailey Corporation, a manufacturer of medical supplies and equipment, is planning to sell its shares to the general public for the first time. The firm’s investment banker, Robert Merrill and Company, is working with Bailey Corporation in determining a number of items. Information on the Bailey Corporation follows:
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
d. Now assume that, of the initial 800,000 share distribution, 400,000 belong to current stockholders and 400,000 are new shares, and the latter will be added to the 1,800,000 shares currently outstanding. What will earnings per share be immediately after the public offering? What will the initial market price of the stock be? Assume a price-earnings ratio of 12, and use earnings per share after the distribution in the calculation.

Expert verified

Answer

The earnings per share will be $1.44 and the initial market price will be $17.28.

Step by step solution

Net income = $3,162,000

Shares outstanding = 1,800,000

Shares issued to public = 400,000 shares

PE ratio = 12 times

The earnings per share after the issue is $1.44.

$E a r n i n g s p e r s h a r e = \frac{E a r n i n g s}{N u m b e r o f s h a r e s} = \frac{$ 3, 162, 000}{2, 200, 000} = $ 1.44$

The initial market price will be $17.28.

$I n i t i a l m a r k e t p r i c e = E P S \times P E r a t i o = $ 1.44 \times 12 t i m e s = $ 17.28$

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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