Question

Wayne, Inc., wishes to expand its facilities. The company currently has 5 million shares outstanding and no debt. The stock sells for $36 per share, but the book value per share is $10. Net income is currently $4 million. The new facility will cost $45 million, and it will increase net income by $800,000. 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.)
a-2.	Calculate the new EPS. (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)
a-3.	Calculate the new stock price. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
a-4.	Calculate the new market-to-book ratio. (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)
b.	What would the new net income for the company have to be for the stock price to remain unchanged? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole dollar amount, e.g., 1,234,567.)

Answer 1

a-1:

Book value per share = (Existing book value of existing shares + Value of new shares issued)/ total number of shares after issue

Number of new shares issued = Finance required for new facility/ market price per share = 45,000,000/36 = 1,250,000

Book value per share = ((5,000,000*10)+(1,250,000*36))/ (5,000,000+1,250,000) = $15.20

a-2.

New EPS = Current Net Income + Increase in net income post new facility / total number of shares after issue

= (4000000+800000)/(5000000+1250000) = 0.7680

a-3:

New Share Price =P/E Ratio x New EPS

Assuming constant P/E Ratio, the P/E Ratio prior to new issue = (Market value of shares/ Earnings) = (5000000*36)/4000000 = 45.00

New Share Price = 45*0.7680 = $34.56

a-4:

New Market to Book ratio =New Share Price / New Book Value of the Share.= 34.56/ 15.20 = 2.2737

b. Since the P/E remains unchanged, the EPS must also remain constant

EPS (constant) = 4000000/5000000 = 0.80

EPS = Total earnings / No. of shares

0.80 = Total earnings / (5000000+1250000) = 5,000,000

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