Question

Cheer, Inc., wishes to expand its facilities. The company currently has 8 million shares outstanding and no debt. The stock sells for $34 per share, but the book value per share is $42. Net income for Teardrop is currently $4.7 million. The new facility will cost $50 million and will increase net income by $800,000. The par value of the stock is $1 per share. Assume a constant price-earnings ratio.

a-1.	Calculate the new book value per share. Assume the stock price is constant. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
a-2.	Calculate the new total earnings. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.)
a-3.	Calculate the new EPS. Include the incremental net income in your calculations. (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)
a-4.	Calculate the new stock price. Include the incremental net income in your calculations. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
a-5.	Calculate the new market-to-book ratio. (Do not round intermediate calculations and round your answer to 3 decimal places, e.g., 32.161.)
b.	What would the new net income for the company have to be for the stock price to remain unchanged? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.)

Answer 1

Solution :-  (A)

(1) :- Book value per share = Total Assets / Total Number of Shares

Total Assets = ( $42 * 8,000,000 ) + $50,000,000 = $386,000,000

Total No. of Shares = ( $50,000,000 / 34 ) + 800,000 = 9,470,588.24

Book Value per share = $386,000,000 / 9,470,588.24

= $40.76

(2)

New Total Earnings = Current Net Income + Additional Income

= $4,700,000 + 800,000

= $5,500,000

(3)

New EPS = New Earnings / New total number of shares

= $5,500,000 / 9,470,588.24

= $0.581

(4)

New Price of Stock =

Old EPS = 4,700,000 / 8,000,000 = 0.5875

New Price = P/E Ratio * New EPS

= ( 34 / 0.5875 ) * 0.5807

= $33.61

(5) New Market to Book Ratio

= Market price / Book Value

= $33.61 / $40.76

= 0.825 times

(b)

Net Income = EPS old * Total New number of shares

= $0.5875 * 9,470,588

= $5,563,970.45

If there is any doubt please ask in comments

Thank you please rate