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Chapter 5: 19BP_e (page 498)

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.

e. Determine what rate of return must be earned on the proceeds to the corporation so there will be a 5 percent increase in earnings per share during the year of going public.

Short Answer

Expert verified

The rate of return required is 17.29%.

Step by step solution

01

Information available

After-tax earnings = $7,200,000

Shares outstanding = 2,100,000

Shares issued in new public issue = 800,000 shares

Selling price for new public issue = $25 per share

Spread = 5%

Out-of-pocket costs = $260,000

Net proceeds = $18,740,000

02

Calculation of net earnings required after stock issue to maintain before issue EPS

The net earnings required is $10.440,000.

EPSrequired=NetearningsSharesoutstanding+5%increaseinEPS=$7,200,0002,100,000+5%increaseinEPS=$3.43+5%increaseinEPS=$3.60Netearnings=EPS脳Sharesoutstanding=$3.6脳2,900,000=$10,440,000

03

Calculation of additional earnings required

The additional earnings required is $3,240,000.

Additionalearnings=Earningsrequiredafterstockissue-Aftertaxearnings=$10,440,000-$7,200,000=$3,240,000

04

Calculation of rate of return to be generated on the net proceeds

The rate of return required is 17.29%.

Rateofreturn=AdditionalearningsrequiredNetproceeds=$3,240,000$18,740,000=17.29%

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Most popular questions from this chapter

What cost of capital is generally used in evaluating a bond refunding decision? Why?

Kevin鈥檚 Bacon Company Inc. has earnings of \(9 million with 2,100,000 shares outstanding before a public distribution. Seven hundred thousand shares will be included in the sale, of which 400,000 are new corporate shares, and 300,000 are shares currently owned by Ann Fry, the founder and CEO. The 300,000 shares that Ann is selling are referred to as a secondary offering, and all proceeds will go to her.

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Question: Barton Simpson, the chief financial officer of Broadband Inc. could hardly believe the change in interest rates that had taken place over the last few months. The interest rate on A2 rated bonds was now 6 percent. The \(30 million, 15-year bond issue that his firm has outstanding was initially issued at 9 percent five years ago. Because interest rates had gone down so much, he was considering refunding the bond issue. The old issue had a call premium of 8 percent. The underwriting cost on the old issue had been 3 percent of par, and on the new issue it would be 5 percent of par. The tax rate would be 30 percent and a 4 percent discount rate would be applied for the refunding decision. The new bond would have a 10-year life. Before Barton used the 8 percent call provision to reacquire the old bonds, he wanted to make sure he could not buy them back cheaper in the open market.

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