Midland Corporation has a net income of
a. How many shares of stock must be sold to net
b. Why is the investment banker selling the stock at less than its current market price?
c. What are the earnings per share (EPS) and the price-earnings ratio before the issue (based on a stock price of
d. Compute the EPS and the price (P/E stays constant) after the new production facility begins to produce a profit.
e. Are the shareholders better off because of the sale of stock and the resultant investment? What other financing strategy could the company have tried to increase earnings per share?
a.
To calculate: The number of shares to be sold at $21,120,000 for Midland Corporation.
Introduction:
Share Price:
The highest price of one share of a company that an investor is willing to pay is termed as the share’s price. It is the current price used for the trading of such shares.
Answer to Problem 18P
The number of shares to be sold at $21,120,000 are 500,000 shares.
Explanation of Solution
The calculation of the number of shares:
Working Note:
The calculation of Net Price:
b.
To explain: The reason as to why an investment banker would sell a stock at less than its market price at present for Midland Corporation.
Introduction:
Share Price:
The highest price of one share of a company that an investor is willing to pay is termed as the share’s price. It is the current price used for the trading of such shares.
Answer to Problem 18P
The investment banker is selling the stock at a price lesser than its market price at present for Midland Corporation so as to create a sufficient demand to sell all the shares. Thus, this method increases the demand among the shareholders.
Explanation of Solution
The new shares may increase the total number of outstanding shares and leads to the dilution of EPS. This dilution will reduce the stock price in the market until the income included from the new assets and the market will pay for the stock.
c.
To calculate: The EPS and the P/E ratio before the issue and also calculate the price for each share right after the stock is sold, if P/E remains the same.
Introduction:
P/E ratio:
It is calculated by dividing a company’s share price at present by its EPS. It helps in valuing a company’s profitability in the present as well as in the future.
Earnings per share (EPS):
It is the profit per outstanding share of a public company. A higher EPS indicates higher value of the company because investors are ready to pay higher price for one share of the company.
Share Price:
The highest price of one share of a company that an investor is willing to pay is termed as the share’s price. It is the current price used for the trading of such shares.
Answer to Problem 18P
For Midland Corporation, the EPS is $4.75 and P/E ratio is 10.11 times and price per share after the sale of stock is $42.66.
Explanation of Solution
The calculation of EPS:
The calculation of P/E ratio:
The calculation of price per share:
Working Note:
The calculation of EPS after offering:
d.
To calculate: The EPS and the price after profit is produced by the new production facility, if the P/E remains the same.
Introduction:
P/E ratio:
It is calculated by dividing a company’s share price at present by its EPS. It helps in valuing a company’s profitability in the present as well as in the future.
Earnings per share (EPS):
It is the profit per outstanding share of a public company. A higher EPS indicates higher value of the company because investors are ready to pay higher price for one share of the company.Â
Answer to Problem 18P
For Midland Corporation, the EPS after contribution will be $4.83 and the price per share will be $48.33.
Explanation of Solution
The calculation of EPS after contribution:
The calculation of Price per share:
Working Note:
The calculation of net income after contribution:
e.
To determine: Whether the shareholders are at a better state after the sale of stock and the consequential investment. Explain the other financing strategies that can be used by the company in order to increase its EPS.
Introduction:
Earnings per share (EPS):
It is the profit per outstanding share of a public company. A higher EPS indicates higher value of the company because investors are ready to pay higher price for one share of the company.
Share Price:
The highest price of one share of a company that an investor is willing to pay is termed as the share’s price. It is the current price used for the trading of such shares.
Answer to Problem 18P
Yes, the shareholders appear better off because of the stock sale as it generates additional investment and the company could use the combination of debt and equity strategy for increasing its EPS.
Explanation of Solution
The shareholders would appear better in the long term due to the raising of additional investments to the company and if the debt financing or combination of debt and equity might be used by the firm then it may lead to the increment of the EPS of the firm.
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Chapter 15 Solutions
Foundations of Financial Management
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