Chapter 15: Investment Banking: Public and Private Placement
15-19. Solution:
Presley Corporation
a. $25 Price 95% = $23.75 Net Price
b. Earnings per Share before Stock Issue =
c. Earnings per Share after Stock Issue = $7,200,000/2,900,000
d. There are now 2,900,000 shares outstanding. To maintain
earnings of $3.43 per share, total earnings must be
e. $3.43 (1.05) = $3.60 (5.00% increase in EPS)
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Chapter 15: Investment Banking: Public and Private Placement
20. Dilution and rates of return (LO15-3) Tyson Iron Works is about to go public. It
currently has aftertax earnings of $4,400,000, and 4,200,000 shares are owned by the
present stockholders. The new public issue will represent 500,000 new shares. The new
shares will be priced to the public at $25 per share with a 3 percent spread on the offering
price. There will also be $280,000 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
b. Earnings per Share before Stock Issue =
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Chapter 15: Investment Banking: Public and Private Placement
d. There are now 4,700,000 shares outstanding. To maintain
earnings per share of $1.05, total earnings must be
e. $1.05 (1.10) = $1.16 (10% increase in EPS)
21. Aftermarket for new public issue (LO15-4) I. B. Michaels has a chance to participate in a
new public offering by Hi-Tech Micro Computers. His broker informs him that demand for
the 700,000 shares to be issued is very strong. His broker’s firm is assigned 25,000 shares
in the distribution and will allow Michaels, a relatively good customer, 1.3 percent of its
25,000 share allocation.
The initial offering price is $30 per share. There is a strong aftermarket, and
the stock goes to $32 one week after issue. The first full month after issue,
Mr. Michaels is pleased to observe his shares are selling for $33.50. He is content to place
his shares in a lockbox and eventually use their anticipated increased value to help send his
son to college many years in the future. However, one year after the distribution, he looks
up the shares in The Wall Street Journal and finds they are trading at $28.50.
a. Compute the total dollar profit or loss on Mr. Michaels’ shares one week, one month,
and one year after the purchase. In each case, compute the profit or loss against the
initial purchase price.
b. Also compute the percentage gain or loss from the initial $30 price.
c. Why might a new public issue be expected to have a strong aftermarket?
15-21. Solution:
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Chapter 15: Investment Banking: Public and Private Placement
I. B. Michaels
a. Mr. Michaels’ Purchase = 1.3% 25,000 shares = 325 shares
Dollar profit or loss
b. Percentage profit or loss
c. A new public issue may be expected to have a strong
22. Leveraged buyout (LO15-5) The management of Mitchell Labs decided to go private in
2002 by buying all 2.80 million of its outstanding shares at $24.80 per share. By 2006,
management had restructured the company by selling off the petroleum research division
for $10.75 million, the fiber technology division for $8.45 million, and the synthetic
products division for $20 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
$1.10 this year. Investment bankers have contacted the firm and indicated that if it
reentered the public market, the 2.80 million shares it purchased to go private could now be
reissued to the public at a P/E ratio of 15 times earnings per share.
a. What was the initial 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 2.80 million shares (based on current
earnings and an anticipated P/E of 15)?
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:
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Chapter 15: Investment Banking: Public and Private Placement
Mitchell Labs
b. Proceeds from sale of the divisions
Current value of the 2.80 million shares
15-22. (Continued)
c. Total Value to the Company $85.4 million
COMPREHENSIVE PROBLEM
Bailey Corporation (impact of new public offering) (LO15-4) The Bailey Corporation, a
manufacturer of medical supplies and equipment, is planning to sell its shares to the general
public for the first time. The firm’s investment banker, Robert Merrill and Company, is working
with Bailey Corporation in determining a number of items. Information on the Bailey
Corporation follows:
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of McGraw-Hill Education.
Chapter 15: Investment Banking: Public and Private Placement
BAILEY CORPORATION
Income Statement
For the Year 20X1
Sales (all on credit)……………………………………. $42,680,000
Cost of goods sold……………………………………... 32,240,000
Gross profit…………………………….…………….….. 10,440,000
Selling and administrative expenses..….……….. 4,558,000
Operating profit……………………………………….... 5,882,000
Interest expense……………………………………….... 600,000
Net income before taxes……………………………… 5,282,000
Taxes…………………………………………………….…. 2,120,000
Net income……………………………………..…….….. $ 3,162,000
CP 15-1. (Continued)
BAILEY CORPORATION
Balance Sheet
As of December 31, 20X1
Assets
Current assets
Cash…………………………………………………….. $ 250,000
Marketable securities…………….………………. 130,000
Accounts receivable……………………..……….. 6,000,000
Inventory…………………………………….……….. 8,300,000
Total current assets………………………………. $14,680,000
Net plant and equipment………………..…….…….. 13,970,000
Total assets…………………………………….……….… $28,650,000
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable………………………..………… $ 3,800,000
Notes payable……………………………………….. 3,550,000
Total current liabilities……………………….. 7,350,000
Long-term liabilities…………………………………… 5,620,000
Total liabilities………………….……….……………… $12,970,000
Stockholders’ equity:
Common stock (1,800,000 shares at $1 par). $ 1,800,000
Capital in excess of par………………..….……… 6,300,000
Retained earnings………………………………..…. 7,580,000
Total stockholders’ equity………..……………. 15,680,000
Total liabilities and stockholders’ equity.......... $28,650,000
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Chapter 15: Investment Banking: Public and Private Placement
a. Assume that 800,000 new corporate shares will be issued to the general public. What
will earnings per share be immediately after the public offering? (Round to two places
to the right of the decimal point.) Based on the price-earnings ratio of 12, what will the
initial price of the stock be? Use earnings per share after the distribution in the
calculation.
b. Assuming an underwriting spread of 5 percent and out-of-pocket costs of $300,000,
what will net proceeds to the corporation be?
c. What return must the corporation earn on the net proceeds to equal the earnings per
share before the offering? How does this compare with current return on the total assets
on the balance sheet?
d. Now assume that, of the initial 800,000-share distribution, 400,000 belong to current
stockholders and 400,000 are new shares, and the latter will be added to the 1,800,000
shares currently outstanding. What will earnings per share be immediately after the
public offering? What will the initial market price of the stock be? Assume a
price-earnings ratio of 12, and use earnings per share after the distribution in the
calculation.
e. Assuming an underwriting spread of 5 percent and out-of-pocket costs of $300,000,
what will net proceeds to the corporation be?
f. What return must the corporation now earn on the net proceeds to equal earnings per
share before the offering? How does this compare with the current return on the total
assets on the balance sheet?
CP 15-1. Solution:
New Public Offering
Bailey Corporation
Earnings
a. Earnings per share (after) Shares
$3,162,000 $3,162,000
$1.22
1,800,000 800,000 2,600,000
Initial market price P/E EPS
12 $1.22 $14.64
=
= =
+
= ´
= ´ =
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Chapter 15: Investment Banking: Public and Private Placement
b. 800,000 shares $14.64 $11,712,000 gross proceeds
585,600 5% spread
300,000 out-of-pocket costs
$10,826,400 net proceeds
´ =
–
–
Earnings
c. Earnings per share (before) Shares
$3,162,000 $1.76
1,800,000
=
= =
In order to earn $1.76 after the offering, the return on
$10,826,400 must produce new earnings equal to X.
$3,162,00 $1.76
1,800,000 800,000
$3,162,000 $1.76 (2,600,00)
X
X
+=
+
+ =
$3,162,000 $1.76
2,600,000
X+=
$4,576,000 $3,162,000
$1,414,000
X
X
= –
=
Chapter 15: Investment Banking: Public and Private Placement
Proof:
$3,162,000 $1,414,000 $4,576,000
$1.76
1,800,000 800,000 2,600,000
New earnings $1,414,000
thus: 13.06%
New proceeds $10,826,400
+= =
+
= =
The firm must earn 13.06 percent on net proceeds to equal
earnings per share before the offering.
Chapter 15: Investment Banking: Public and Private Placement
f.
$3,162,000 $1.76
1,800,000 400,000
$3,162,000 $1.76
2,200,000
X
X
+=
+
+=
$3,162,000 + X = $1.76 (2,200,000)
X = $3,872,000 – $3,162,000
X = $710,000
Proof:
$3,162,000 $710,000 $3,872,000 $1.76
1,800,000 400,000 2,200,000
+= =
+
CP 15-1. (Continued)
thus:
New earnings $710,000 11.33%
Net proceeds $6,266,400
= =
This is greater than the current return on assets of 11.04
percent.
Net income $3,162,000 11.04%
Total assets $28,650,000
= =