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Chapter 5: Q8DQ (page 594)
How is a stock split (versus a stock dividend) treated on the financial statements of a corporation?
The stock split results in a reduction in the value of one stock and an increase in the number of outstanding shares in the common stock account.
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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 |
c. What return must the corporation earn on the net proceeds to equal the earnings per share before the offering? How does this compare with current return on the total assets on the balance sheet?
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?
Richmond Rent-A-Car is about to go public. The investment banking firm of Tinkers, Evers & Chance is attempting to price the issue. The car rental industry generally trades at a 20 percent discount below the P/E ratio on the Standard & Poor’s 500 Stock Index. Assume that index currently has a P/E ratio of 25. The firm can be compared to the car rental industry as follows:
Richmond | Car Rental Industry | |
Growth rate in earnings per share..... | 15% | 10% |
Consistency of performance............. | Increased earnings 4 out of 5 years | Increased earnings 3 out of 5 years |
Debt to total assets..................... | 52% | 39% |
Turnover of product......................... | Slightly below average | Average |
Quality of management.................. | High | Average |
Assume, in assessing the initial P/E ratio, the investment banker will first determine the appropriate industry P/E based on the Standard & Poor’s 500 Index. Then a half point will be added to the P/E ratio for each case in which Richmond Rent-A-Car is superior to the industry norm, and a half point will be deducted for an inferior comparison. On this basis, what should the initial P/E be for the firm?
What are electronic communication networks (ECNs)? Generally speaking, are they currently part of the operations of the New York Stock Exchange and the NASDAQ Stock Market?
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.
c. Calculate the net present value.
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