Question

Midland Corporation has a net income of $17 million and 5 million shares outstanding. Its common stock is currently selling for $43 per share. Midland plans to sell common stock to set up a major new production facility with a net cost of $26,600,000. The production facility will not produce a profit for one year, and then it is expected to earn a 14 percent return on the investment. Wood and Gundy, an investment dealer, plans to sell the issue to the public for $40 per share, with a spread of 5 percent.

a. How many shares of stock must be sold to net $26,600,000? (Note: No out-of-pocket costs must be considered in this problem.) Number of shares

b. Not available in Connect.

c. What are the EPS and the P/E ratio before the issue (based on a stock price of $43)? What will be the price per share immediately after the sale of stock if the P/E stays constant? (Round the intermediate calculations and the final answer to 2 decimal places. Enter the answers in dollars not in millions.) EPS before offering $ P/E ratio X EPS after offering $ Price $

d. Compute the EPS and the price (P/E stays constant) after the new production facility begins to produce a profit. (Round the intermediate calculations and the final answer to 2 decimal places. Enter the answers in dollars not in millions.) EPS after contribution $ Price $

Answer 1

(a)

Compute the number of shares issued to finance the funds needed, using the equation as shown below:

Shares issued = Funds needed/ {Share price*(1 – Spread)}

                       = $26,600,000/ {$40*(1 – 0.05)}

                       = $26,600,000/ $38

                       = 700,000 shares

Hence, the number of shares issued is 700,000 shares.

(c)

Compute the earnings per share (EPS), using the equation as shown below:

EPS = Net income/ Shares outstanding

        = $17 million/ 5 million

        = $3.40 per share

Hence, the EPS is $3.40.

Compute the price/ earnings (P/E) ratio, using the equation as shown below:

P/E ratio = Market price/ Earnings per share

             = $43/ $3.40

               = 12.65 times

Hence, the P/E ratio is 12.65 times.

Compute the new earnings per share (EPS), using the equation as shown below:

EPS = Net income/ (Existing shares + New share)

        = $17,000,000/ (5,000,000 shares + 700,000 shares)

       = $2.98

Hence, the new EPS is $2.98.

Compute the price per share after the new issue, using the equation as shown below:

Price = New EPS*P/E ratio

         = $2.98*12.65 times

         = $37.70

Hence, the price after the new issue is $37.70 per share.

(d)

Compute the total investment amount, using the equation as shown below:

Total investment = (Existing shares*Market price) + New investment

                            = (5,000,000*$43) + $26,600,000

                            = $241,600,000

Hence, the total investment amount is $241,600,000.

Compute the earnings per share (EPS), using the equation as shown below:

EPS = Total investment/ Share outstanding

       = $241,600,000/ 5,700,000 shares

        = $42.38

Hence, the EPS is $42.38.

Compute the price, using the equation as shown below:

Price = EPS*P/E ratio

         = $42.38*12.65

         = $536.107

Hence, the price is $536.107 per share.