Question

Cheer, Inc., wishes to expand its facilities. The company currently has 12 million shares outstanding and no debt. The stock sells for $27 per share, but the book value per share is $36. Net income for Teardrop is currently $5.1 million. The new facility will cost $60 million and will increase net income by $920,000. The par value of the stock is $1 per share. Assume a constant price-earnings ratio.

a-1.	Calculate the new book value per share. Assume the stock price is constant. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
a-2.	Calculate the new total earnings. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.)
a-3.	Calculate the new EPS. Include the incremental net income in your calculations. (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)
a-4.	Calculate the new stock price. Include the incremental net income in your calculations. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
a-5.	Calculate the new market-to-book ratio. (Do not round intermediate calculations and round your answer to 3 decimal places, e.g., 32.161.)
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 answers in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.)

      

Answer 1

Solution:

a-1: First, we calculate the number of shares after offering

Number of shares after offering = 12 million + $60 million/$27

Number of shares after offering = 12 million + 2.22222 million

Number of shares after offering = 14.22222 million

Now, we calculate the new book value per share

New book value per share = Book value after offering/Number of shares after offering

New book value per share = [12 million x $36 + 2.2222 million x $27]14.22222 million

New book value per share = $34.59

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a-2: When net income will increase by $920,000, the new total earnings would be

New total earnings = $5,100,000 + $920,000

New total earnings = $6,020,000

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a-3: The new EPS is calculated using the formula

New EPS = New total earnings/Total number of outstanding shares

New EPS = $6,020,000/14,222,222

New EPS = $0.4233

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a-4: For new stock price, we calculate the current EPS and current P/E ratio

Current EPS = Current net income/Current outstanding shares

Current EPS = $5,100,000/12,000,000

Current EPS = $0.425

P/E ratio = Market price of the share/EPS

P/E ratio = $27/$0.425

P/E ratio = 63.529 times

New stock price = P/E ratio x New EPS

New stock price = 63.529 x $0.4233

New stock price = $26.89

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a-5: The new market to book ratio is calculated using the formula

New market to book ratio = New share price/New book value of share

New market to book ratio = $26.89/$34.59

new market to book ratio = 0.777

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b. Since the P/E ratio remains unchanged, EPS should also remain unchanged. The new net income would be

Net income= Number of shares x EPS

Net Income = 14,222,222 x $0.4233

Net Income = $6,020,267