Dr. Robert Grossman founded Electro Cardio Systems Inc. (ECS) in 2001. The principal purpose of the firm was to engage in research and development of heart pump devices. Although the firm did not show a profit until 2006, by 2010 it reported after-tax earnings of \(1,200,000. The company had gone public in 2004 at \)10 a share. Investors were initially interested in buying the stock because of its future prospects. By year-end 2010, the stock was trading at \(42 per share because the firm had made good on its promise to produce lifesaving heart pumps and, in the process, was now making reasonable earnings. With 850,000 shares outstanding, earnings per share were \)1.41.

Dr. Grossman and the members of the board of directors were initially pleased when another firm, Parker Medical Products, began buying their stock. John Parker, the chairman and CEO of Parker Medical Products, was thought to be a shrewd investor and his company’s purchase of 50,000 shares of ECS was taken as an affirmation of the success of the heart pump research firm.

However, when Parker bought another 50,000 shares, Dr. Grossman and members of the board of directors of ECS became concerned that John Parker and his firm might be trying to take over ECS.

Upon talking to his attorney, Dr. Grossman was reminded that ECS had a poison pill provision that took effect when any outside investor accumulated 25 percent or more of the shares outstanding. Current stockholders, excluding the potential takeover company, were given the privilege of buying up to 500,000 new shares of ECS at 80 percent of current market value. Thus new shares would be restricted to friendly interests.

The attorney also found that Dr. Grossman and “friendly” members of the board of directors currently owned 175,000 shares of ECS.

a. How many more shares would Parker Medical Products need to purchase before the poison pill provision would go into effect? Given the current price of ECS stock of $42, what would be the cost to Parker to get up to that level?

b. ECS’s ultimate fear was that Parker Medical Products would gain over a 50 percent interest in ECS’s outstanding shares. What would be the additional cost to Parker to get 50 percent (plus 1 share) of the stock outstanding of ECS at the current market price of ECS stock? In answering this question, assume Parker had previously accumulated the 25 percent position discussed in question a.

c. Now assume that Parker exceeds the number of shares you computed in part b and gets all the way up to accumulating 625,000 shares of ECS. Under the poison pill provision, how many shares must “friendly” shareholders purchase to thwart a takeover attempt by Parker? What will be the total cost? Keep in mind that friendly interests already own 175,000 shares of ECS and to maintain control, they must own one more share than Parker.

d. Would you say the poison pill is an effective deterrent in this case? Is the poison pill in the best interest of the general stockholders (those not associated with the company)?

Step by step solution

01

Shares to be purchased for poison pill

Parker medical products will have to acquire 25% of outstanding shares for poison pill. They would be required to get 112,500 additional shares for poison pill.

$$\begin{gathered} \mathit{S}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathit{s}\mathbf{}\mathit{r}\mathit{e}\mathit{q}\mathit{u}\mathit{i}\mathit{r}\mathit{e}\mathit{d}\mathbf{}\mathit{f}\mathit{o}\mathit{r}\mathbf{}\mathit{p}\mathit{o}\mathit{i}\mathit{s}\mathit{o}\mathit{n}\mathbf{}\mathit{p}\mathit{i}\mathit{l}\mathit{l}\mathbf{=}\mathit{S}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathit{s}\mathbf{}\mathit{o}\mathit{u}\mathit{t}\mathit{s}\mathit{t}\mathit{a}\mathit{n}\mathit{d}\mathit{i}\mathit{n}\mathit{g}\mathbf{\times }\mathbf{25}\mathbf{\%} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{850}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{25}\mathbf{\%} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{212}\mathbf{,}\mathbf{500} \end{gathered}$$
$$\begin{gathered} \mathit{S}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathit{s}\mathbf{}\mathit{t}\mathit{o}\mathbf{}\mathit{b}\mathit{e}\mathbf{}\mathit{p}\mathit{u}\mathit{r}\mathit{c}\mathit{h}\mathit{a}\mathit{s}\mathit{e}\mathit{d}\mathbf{=}\mathit{S}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathit{s}\mathbf{}\mathit{o}\mathit{w}\mathit{n}\mathit{e}\mathit{d}\mathbf{-}\mathit{S}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathit{s}\mathbf{}\mathit{r}\mathit{e}\mathit{q}\mathit{u}\mathit{i}\mathit{r}\mathit{e}\mathit{d}\mathbf{}\mathit{f}\mathit{o}\mathit{r}\mathbf{}\mathit{p}\mathit{o}\mathit{i}\mathit{s}\mathit{o}\mathit{n}\mathbf{}\mathit{p}\mathit{i}\mathit{l}\mathit{l} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{212}\mathbf{,}\mathbf{500}\mathbf{-}\mathbf{100}\mathbf{,}\mathbf{000} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{112}\mathbf{,}\mathbf{500} \end{gathered}$$

02

Cost of additional shares to Parker

The cost of additional shares will be $4,725,000.

$$\begin{gathered} \mathit{C}\mathit{o}\mathit{s}\mathit{t}\mathbf{}\mathit{o}\mathit{f}\mathbf{}\mathit{a}\mathit{d}\mathit{d}\mathit{i}\mathit{t}\mathit{i}\mathit{o}\mathit{n}\mathit{a}\mathit{l}\mathbf{}\mathit{s}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathit{s}\mathbf{=}\mathit{A}\mathit{d}\mathit{d}\mathit{i}\mathit{t}\mathit{i}\mathit{o}\mathit{n}\mathit{a}\mathit{l}\mathbf{}\mathit{s}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathit{s}\mathbf{}\mathit{r}\mathit{e}\mathit{q}\mathit{u}\mathit{i}\mathit{r}\mathit{e}\mathit{d}\mathbf{\times }\mathit{S}\mathit{t}\mathit{o}\mathit{c}\mathit{k}\mathbf{}\mathit{p}\mathit{r}\mathit{i}\mathit{c}\mathit{e} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{112}\mathbf{,}\mathbf{500}\mathbf{\times }\mathbf{\$}\mathbf{42} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{\$}\mathbf{4}\mathbf{,}\mathbf{725}\mathbf{,}\mathbf{000} \end{gathered}$$

03

Calculation of cost of additional shares

The cost of additional shares is $8,925,042.

$$\begin{gathered} \mathit{C}\mathit{o}\mathit{s}\mathit{t}\mathbf{=}\mathit{S}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathit{s}\mathbf{}\mathit{t}\mathit{o}\mathbf{}\mathit{b}\mathit{e}\mathbf{}\mathit{p}\mathit{u}\mathit{r}\mathit{c}\mathit{h}\mathit{a}\mathit{s}\mathit{e}\mathit{d}\mathbf{\times }\mathit{S}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathbf{}\mathit{p}\mathit{r}\mathit{i}\mathit{c}\mathit{e} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{212}\mathbf{,}\mathbf{501}\mathbf{\times }\mathbf{\$}\mathbf{42} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{\$}\mathbf{8}\mathbf{,}\mathbf{925}\mathbf{,}\mathbf{042} \end{gathered}$$

04

Calculation of additional shares to be purchased

Additional shares to be purchased by friendly stakeholders are 450,000 shares.

$$\begin{gathered} \mathit{A}\mathit{d}\mathit{d}\mathit{i}\mathit{t}\mathit{i}\mathit{o}\mathit{n}\mathit{a}\mathit{l}\mathbf{}\mathit{s}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathit{s}\mathbf{=}\mathit{S}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathit{s}\mathbf{}\mathit{h}\mathit{e}\mathit{l}\mathit{d}\mathbf{}\mathit{b}\mathit{y}\mathbf{}\mathit{P}\mathit{a}\mathit{r}\mathit{k}\mathit{e}\mathit{r}\mathbf{-}\mathit{S}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathbf{}\mathit{h}\mathit{e}\mathit{l}\mathit{d}\mathbf{}\mathit{b}\mathit{y}\mathbf{}\mathit{f}\mathit{r}\mathit{i}\mathit{e}\mathit{n}\mathit{d}\mathit{l}\mathit{y}\mathbf{}\mathit{s}\mathit{t}\mathit{a}\mathit{k}\mathit{e}\mathit{h}\mathit{o}\mathit{l}\mathit{d}\mathit{e}\mathit{r}\mathit{s} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{625}\mathbf{,}\mathbf{000}\mathbf{-}\mathbf{175}\mathbf{,}\mathbf{000} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{450}\mathbf{,}\mathbf{000} \end{gathered}$$

05

Calculation of cost of additional shares

The cost of additional shares is $18,900,000.

$$\begin{gathered} \mathit{C}\mathit{o}\mathit{s}\mathit{t}\mathbf{=}\mathit{S}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathit{s}\mathbf{}\mathit{t}\mathit{o}\mathbf{}\mathit{b}\mathit{r}\mathbf{}\mathit{p}\mathit{u}\mathit{r}\mathit{c}\mathit{h}\mathit{a}\mathit{s}\mathit{e}\mathit{d}\mathbf{\times }\mathit{S}\mathit{h}\mathit{a}\mathit{r}\mathit{e}\mathbf{}\mathit{p}\mathit{r}\mathit{i}\mathit{c}\mathit{e} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{450}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{\$}\mathbf{42} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{18}\mathbf{,}\mathbf{900}\mathbf{,}\mathbf{000} \end{gathered}$$

06

Reason poison pill is an effective deterrent

The poison pill is an effective deterrent as the company has 850,000 outstanding shares out of which 100,000 is held by Parker medical products and 175,000 by friendly investors. Parker can acquire maximum 625,000 shares and the friendly investors can acquire up to 700,000 shares which is more than the number of shares that can be acquired by Parker.

07

Impact of poison pill on general stockholders

The poison pill is not in the best interest of general stockholders because without the poison oil, there is more chance that Parker medical products will take over the ESC. The take over will help in getting a better value for the company rather than the poison pill provision.

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