Question

The Presley Corporation is about to go public. It currently has aftertax earnings of $7,000,000, and 2,000,000 shares are owned by the present stockholders (the Presley family). The new public issue will represent 500,000 new shares. The new shares will be priced to the public at $25 per share, with a 4 percent spread on the offering price. There will also be $250,000 in out-of-pocket costs to the corporation.

a. Compute the net proceeds to the Presley Corporation. (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

b. Compute the earnings per share immediately before the stock issue. (Do not round intermediate calculations and round your answer to 2 decimal places.)

c. Compute the earnings per share immediately after the stock issue. (Do not round intermediate calculations and round your answer to 2 decimal places.)

d. Determine what rate of return must be earned on the net proceeds to the corporation so there will not be a dilution in earnings per share during the year of going public. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

e. Determine what rate of return must be earned on the proceeds to the corporation so there will be a 5 percent increase in earnings per share during the year of going public. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Answer 1

Given: After tax Earnings = $7,000,000

Shares outstanding = 2,000,000

New Shares = 500,000

Public price = $25

Spread= 4%

Cost =$250,000

a)

NEt Proceeds = [Public price*(1-spread)*New number of shares] - Cost

= [ 25*(1-0.04)*500,000] - 250,000

=$11,750,000

b) EPS before stock issue

EPS before = After tax earnings / Shares outstanding = 7,000,000/ 2,000,000 = $ 3.5

c) EPS after stock issue

EPS after = After Tax earnings / (Total shares after issue) = After tax earnings / (Shares outstanding+new shares)

EPS after = 7,000,000 / (2,000,000+500,000) = $2.8

d) Required after tax earnings = EPS before * (Total shares after issue)

= 3.5 * (2,000,000+500,000) = $8,750,000

Rate of return = (Required after tax earnings - actual after tax earnings)/Net proceeds

= (8,750,000 - 7,000,000) / 11,750,000

= 0.1489 = 14.89%

e) Earnings needed = EPS befor*(1+increase %) *(Total shares after issue)

= 3 * 1.04 *( 2,000,000 +500,000) = $9,100,000

Rate of return = (Required after tax earnings - actual after tax earnings)/Net proceeds

= (9,100,000 -7,000,000) / 11,750,000 = 0.1787

= 17.87%