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Zip Corporation has 3 million shares of outstanding common stock and total earnings of $15,000,000. The...

Zip Corporation has 3 million shares of outstanding common stock and total earnings of $15,000,000. The corporation is considering issuing 1 million more shares of common stock.

What will be the immediate dilution in earning per share (EPS)?

If the new shares will be sold at $20 per share and the proceeds from the sale can be invested at 10%, will there still be dilution? Based on the new EPS, should the new shares of common stock be issued?

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Answer #1

Current EPS before issue of new stock = $15,000,000 / 3,000,000

$5

Current EPS before issue of new stock is $5.

The corporation is considering issuing 1 million more shares of common stock.

So new total share outstanding = 4 million.

New Diluted EPS = $15,000,000 / 4,000,000

= $3.75.

New Diluted EPS is $3.75.

Return on equity before dilution = $15,000,000 / (3,000,000 × $20)

= 25%

Return on equity before dilution is 25% . If the new shares will be sold at $20 per share and the proceeds from the sale can be invested at 10%, will there still be dilution because return on equity is more than 10%.

New EPS become lower than existing EPS, so company should not issue new share.

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