Question

American Health Systems currently has 7,200,000 shares of stock outstanding and will report earnings of $12 million in the current year. The company is considering the issuance of 1,300,000 additional shares that will net $40 per share to the corporation.

a. What is the immediate dilution potential for this new stock issue? (Do not round intermediate calculations and round your answer to 2 decimal places.)
  

b-1. Assume that American Health Systems can earn 15 percent on the proceeds of the stock issue in time to include them in the current year’s results. Calculate earnings per share. (Do not round intermediate calculations and round your answer to 2 decimal places.)

b-2. Should the new issue be undertaken based on earnings per share?
  

	Yes
	No

Answer 1

(a)- The immediate dilution potential for this new stock issue

Earnings per share (EPS) = Net Earnings / Number of common shares outstanding

Earnings per share (EPS) before issuing additional shares = Net Earnings / Number of common shares outstanding

= $1,20,00,000 / 72,00,000 Shares

= $1.66 per share

Earnings per share (EPS) after issuing additional shares = Net Earnings / Number of common shares outstanding

= $1,20,00,000 / [72,00,000 Shares + 13,00,000 Shares]

= $1,20,00,000 / 85,00,000 Shares

= $1.41 per share

Therefore, the dilution in the EPS = $0.25 per share

“The immediate dilution potential for this new stock issue = $0.25 per share”

(b)(1)-Earnings per share

Earnings per share (EPS) = (Net Earnings + 15 percent on the proceeds of the stock issue) / Number of shares outstanding

= [$120,00,000 x (13,00,000 Shares x $40 per share x 0.15)] / 85,00,000 Shares

= [$1,20,00,000 + $78,00,000] / 85,00,000 Shares

= $1,98,00,000 / 85,00,000 Shares

= $2.33 per share

(b)(2)-Decision on the new issue be undertaken based on earnings per share

“YES”. The new issue should be undertaken, since the EPS of $2.33 is higher than $1.66.