Question

Maxwell Corp. is coming to the market with a new offering of 450,000 shares of stock at $22 to the public. Maxwell will receive $19 per share. The firm has one million shares outstanding and earnings of $6 million before recording the new issue. What is the amount of dilution in earnings per share? Hint: flotation costs reduce earnings.

a) $1.38

b) $1.77

c) $2.79

d) No dilution occurs since new money is received by Maxwell

Answer 1

- Net Income or earnings before recording the new issue = $6,000,000

Earnings per share before recording the new issue = Earnings/No of shares outstanding = $6000,000/1000,000

= $6

- Maxwell will issue new offering of 450,000 shares at $22 to public however will receive only $19 due to the difference being flotation cost

Total Flotation Cost = 450,000 shares*($22 - $19) = $1350,000

- Net Income or earnings after the flotation cost =$6,000,000 - $1350,000 = $4650,000

Number of shares after new offering = 1,000,000 shares + 450,000 shares = 1450,000 shares

- Earnings per share after recording the new issue = Net Income or earnings after the flotation cost/Number of shares after new offering

= $4650,000/1450,000

Earnings per share after recording the new issue = $3.21

So, Dilution in earnings per share = Earnings per share before recording the new issue - Earnings per share after recording the new issue

Dilution in earnings per share = $6 - $3.21

Dilution in earnings per share = $2.79

Option C

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