Chapter 15: Investment Banking: Public and Private Placement
15-21
e. In the long run, it appears that the company is better off
because of the additional investment. Earnings per share are
19. Dilution and rates of return (LO3) The Presley Corporation is about to go public. It
currently has aftertax earnings of $7,500,000 and 2,500,000 shares are owned by the
present stockholders (the Presley family). The new public issue will represent 600,000 new
shares. The new shares will be priced to the public at $20 per share, with a 5 percent spread
on the offering price. There will also be $200,000 in out-of-pocket costs to the corporation.
a. Compute the net proceeds to the Presley Corporation.
b. Compute the earnings per share immediately before the stock issue.
c. Compute the earnings per share immediately after the stock issue.
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.
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.
15–19. Solution:
Presley Corporation
a. $20 price 95% = $19 net price
$19 net price
600,000 new shares
b.
$7,500,000
Earnings per share before stock issue $3.00
2,500,000
==
Chapter 15: Investment Banking: Public and Private Placement
15-22
c.
$7,500,000
Earnings per share after stock issue $2.42
3,100,000
==
15–19. (Continued)
d. There are now 3,100,000 shares outstanding. To maintain
earnings of $3 per share, total earnings must be $9,300,000
e. $3.00 (1.05) = $3.15 (5% increase in EPS)
Total earnings = $3.15 3,100,000 shares =
incremental earnings $2,265,000 20.22%
net proceeds $11,200,000
==
and the 5% growth in EPS.
Chapter 15: Investment Banking: Public and Private Placement
15-23
20. Dilution and rates of return (LO3) Tyson Iron Works is about to go public. It currently
has aftertax earnings of $4,500,000 and 3,000,000 shares are owned by the present
stockholders. The new public issue will represent 400,000 new shares. The new shares will
be priced to the public at $15 per share with a 4 percent spread on the offering price. There
will also be $160,000 in out-of-pocket costs to the corporation
a. Compute the net proceeds to Tyson Iron Works.
b. Compute the earnings per share immediately before the stock issue.
c. Compute the earnings per share immediately after the stock issue.
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.
e. Determine what rate of return must be earned on the proceeds to the corporation so
there will be a 10 percent increase in earnings per share during the year of going public.
15–20. Solution:
Tyson Iron Works
a. $15 96% = $14.40 net price
$14.40 net price
400,000 new shares
$4,500,000
b. Earnings per share before stock issue $1.50
3,000,000
==
$4,500,000
c. Earnings per share after stock issue $1.32
3,400,000
==
Chapter 15: Investment Banking: Public and Private Placement
15–20. (Continued)
d. There are now 3,400,000 shares outstanding. To maintain
earnings per share of $1.50, total earnings must be
e. $1.50 (1.10) = $1.65 (10% increase in EPS)
Chapter 15: Investment Banking: Public and Private Placement
15-25
b. Also compute this percentage gain or loss from the initial $30 price and compare this to
the results that might be expected in an investment of this nature based on prior
research. Assume the overall stock market was basically unchanged during the period
of observation.
c. Why might a new public issue be expected to have a strong aftermarket?
15–21. Solution:
I. B. Michaels
a. Mr. Michael’s purchase = 1.5% 15,000 shares = 225 shares
Dollar profit or loss
b. Percentage profit or loss
15–21. (Continued)
The results are in line with prior research. The stock went up
one week and one month after issue, but actually provided a
negative return for one year after issue. This is consistent
Chapter 15: Investment Banking: Public and Private Placement
15-26
22. Leveraged buyout (LO5) The management of Mitchell Labs decided to go private in 2002
by buying in all 3 million of its outstanding shares at $19.50 per share. By 2006,
management had restructured the company by selling off the petroleum research division
for $13 million, the fiber technology division for $9.5 million, and the synthetic products
division for $21 million. Because these divisions had been only marginally profitable,
Mitchell Labs is a stronger company after the restructuring. Mitchell is now able to
concentrate exclusively on contract research and will generate earnings per share of $1.25
this year. Investment bankers have contacted the firm and indicated that if it reentered the
public market, the 3 million shares it purchased to go private could now be reissued to the
public at a P/E ratio of 16 times earnings per share.
a. What was the initial total cost to Mitchell Labs to go private?
b. What is the total value to the company from (1) the proceeds of the divisions that were
sold, as well as (2) the current value of the 3 million shares (based on current earnings
and an anticipated P/E of 16)?
c. What is the percentage return to the management of Mitchell Labs from the
restructuring? Use answers from parts a and b to determine this value.
15–22. Solution:
Mitchell Labs
a. 3 million shares $19.50 = $58.5 million (cost to go private)
b. Proceeds from sale of the divisions
Petroleum research division $13.0 million