Question

Eaton, Inc., wishes to expand its facilities. The company currently has 5 million shares outstanding and no debt. The stock sells for $40 per share, but the book value per share is $10. Net income is currently $3.2 million. The new facility will cost $50 million, and it will increase net income by $760,000. Assume a constant price-earnings ratio.

a-1	Calculate the new book value per share. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Book value

$

a-2	Calculate the new total earnings.

Total earnings

$

a-3	Calculate the new EPS. (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

EPS	$  per share

a-4	Calculate the new stock price. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Stock price

$

a-5	Calculate the new market-to-book ratio. (Do not round intermediate calculations and round your final answer to 4 decimal places, e.g., 32.1616.)

Market-to-book ratio

b.	What would the new net income for the company have to be for the stock price to remain unchanged? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to nearest whole dollar amount, e.g., 32.)

Answer 1

a-1) Current total book value = $10 x 5,000,000 = $50,000,000

New total book value = Current total book value + new facility = $50,000,000 + $50,000,000 = $100,000,000

New shares to be issued = Cost of facility / price per share = $50,000,000 / $40 = 1,250,000 shares

New total no. of shares = 5,000,000 shares + 1,250,000 shares = 6,250,000 shares

New book value per share = $100,000,000 / 6,250,000 = $16

a-2) New total earnings = $3,200,000 + $760,000 = $3,960,000

a-3) New EPS = New earnings / New no. of shares = $3,960,000 / 6,250,000 = $0.6336

a-4) Current EPS = Current earnings / Current no. of shares = $3,200,000 / 5,000,000 = $0.64

Current PE ratio = Current stock price / Current EPS = $40 / $0.64 = 62.5 times

This ratio will remain constant.

New Stock price = New earnings x PE ratio = $0.6336 x 62.5 = $39.60

a-5) New market value = 6,250,000 x $39.60 = $247,500,000

New market-to-book ratio = New market value / New book value = $247,500,000 / $100,000,000 = 2.4750

b) For stock price to remain unchanged, the EPS has to remain at $0.64 per share.

EPS = new earnings / New total no. of shares

or, New Earnings = $0.64 x 6,250,000 = $4,000,000

Therefore, the new earnings has should be $4,000,000 for the stock to remain unchanged.