Question

The Presley Corporation is about to go public. It currently has aftertax earnings of $6,200,000, and 3,600,000 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 $10 per share, with a 3 percent spread on the offering price. There will also be $210,000 in out-of-pocket costs to the corporation.

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

Solution :

After tax earning = $6,200,000

Number of share = 3,600,000 current , 500,000 new shares issue

Share price = $10 , Spread = 3% and out of the pocket cost = $210,000

So we have to find the net proceeds first

Net proceeds = Number of shares issued * Share price * ( 1-spread ) - out of pocket cost

= 500,000 * 10 * (1-0.3) - 210,000 = 4,850,000 - 210,000 = 4,640,000

So the company will have $4,640,000 as net by issuing the shares

Part D )

EPS pre-issue = Earning after tax / Old number of shares = $6,200,000/  3,600,000 = 1.7222

Now after the issue total number of shares = 3,600,000 + 500,000 = 4,100,000

Total Required Earning = EPS pre-issue * total number of shares = 1.7222 * 4,100,000 = 7,061,111

Required rate of return: So we have to increase our earnings from $6,200,000 ( pre-issue) to 7,061,111(post-issue) by getting the net proceeds

So Required rate of return =( Post-issue earning -- pre issue earning) / net prooceeds

= (7,061,111 - 6,200,000 ) / 4,640,000 = 861,111 / 4,640,000 = 0.185584 =18.56%

Part E )

Since there is an increase of 5% in EPS

So required earning after issue = EPS pre-issue * ( 1+ 5%) * Total share after issue

= 1.7222 * 1.05 * 4,100,000 = 7,414,166.67

Required rate of return: So we have to increase our earnings from $6,200,000 ( pre-issue) to 7,414,166.67(post-issue) by getting the net proceeds

So Required rate of return =( Post-issue earning -- pre issue earning) / net prooceeds

= (7,414,166.67 - 6,200,000 ) / 4,640,000 = 1,214,166.67 / 4,640,000

= 0.26167 =26.17%