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Chapter 5: Q3PB (page 495)

American Health Systems currently has 6,400,000 shares of stock outstanding and will report earnings of \(10 million in the current year. The company is considering the issuance of 1,700,000 additional shares that will net \)30 per share to the corporation.

a. What is the immediate dilution potential for this new stock issue?

b. Assume that American Health Systems can earn 9 percent on the proceeds of the stock issue in time to include them in the current year鈥檚 results. Calculate earnings per share. Should the new issue be undertaken based on earnings per share?

Short Answer

Expert verified

a. Immediate dilution is $0.328.

b. New EPS is $1.8012 and the new issue should be undertaken.

Step by step solution

01

Computation of immediate dilution

EPSbeforestockissue=EarningsOutstandingstock=$10,000,0006,400,000=$1.5625EPSafterstockissue=EarningsOutstandingstock+Additionalissue=$10,000,0006,400,000+1,700,000=$10,000,0008,100,000=$1.2345Dilution=EPSbeforestockissue-EPSafterstockissue=$1.5625-$1.2345=$0.328

02

Computation of New EPS

Newincome=ExpectedearningsAdditionalissue脳pricepershare=9%1,700,000脳$30=9%51,000,000=$4,590,000Totalincome=Newincome+Reportedearnings=$4,590,000+$10,000,000=$14,590,000NewEPS=TotalincomeNumberofshares=$14,590,0008,100,000=$1.8012

03

Undertaking of new issue

GrowthinEPS=NewEPS-EPSbeforestockissue=$1.8012-$1.5625=$0.2387

The new issue should be undertaken because there will be no dilution and EPS will grow by $0.2387.

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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.

a. Calculate the present value of total outflows.

What is shelf registration? How does it differ from the traditional requirements for security offerings?

Question: The trustee in the bankruptcy settlement for Titanic Boat Co. lists the following book values and liquidation values for the assets of the corporation. Liabilities and stockholders鈥� claims are also shown.

Assets

Book value

Liquidation value

Accounts receivables

\(1,400,000

\)1,200,000

Inventory

\(1,800,000

\)900,000

Machinery and equipment

\(1,100,000

\)600,000

Building and plant

\(4,200,000

\)2,500,000

Total assets

\(8,500,000

\)5,200,000

Liabilities and stockholder鈥檚 claims

Liabilities

Accounts payable

\(2,800,000

First lien, secured by machinery and equipment

\)900,000

Senior unsecured debt

\(2,200,000

Subordinated debenture

\)1,700,000

Total liabilities

\(7,600,000

Stockholder鈥檚 claims

Preferred stock

\)250,000

Common stock

\(650,000

Total stockholder鈥檚 claims

\)900,000

Total liabilities and stockholder鈥檚 claims

$8,500,000

d. After the machinery and equipment are sold to partially cover the first lien secured claim, how much will be available from the remaining asset liquidation values to cover unsatisfied secured claims and unsecured debt?

Using the information in Problem 3, assume that American Health Systems鈥� 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?

Trump Card Co. will issue stock at a retail (public) price of \(32. The company will receive \)29.20 per share.

a. What is the spread on the issue in the percentage terms?

b. If the firm demands receiving a new price only $2.20 below the public price suggested in part a, what will the spread be in percentage terms?

c. To hold the spread down to 2.5 percent based on the public price in part a, what net amount should Trump Card Co. receive?
See all solutions

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