Enrietto Aquatic Products offer to acquire Fiberglass Products for $2,000,000 cash has been accepted. Enrietto has $1,000,000
Question:
Enriettos policy is to pay 60 percent of net income to stockholders as dividends. Enrietto expects to be able to raise the $1,000,000 it needs for the acquisition by selling 50,000 shares of common stock at $20 each or by issuing $1,000,000 of 20-year, 12 percent bonds. Enrietto expects income from operations to grow by $700,000 after Fiberglass Products has been acquired.
(Interest expense will increase if debt is used to finance the acquisition.)
Required:
1. Determine the return on equity (net income/total equity) before the acquisition and for both financing alternatives.
2. If Enrietto sells additional stock, what will be the cash outï¬ow for dividends?
3. If Enrietto sells bonds, what will be the net cash outï¬ows for new interest and for all dividends? (Remember that interest is tax-deductible.)
4. Assume that Enrietto sells stock and that none of the preacquisition stockholders buy any of the 50,000 new shares. What total amount of dividends will the preacquisition stockholders receive after the acquisition? How does this amount compare with the dividends they receive before the acquisition?
5. Which alternative is better for Enriettos preacquisition stockholders?
Step by Step Answer:
Cornerstones of Financial and Managerial Accounting
ISBN: 978-1111879044
2nd edition
Authors: Rich, Jeff Jones, Dan Heitger, Maryanne Mowen, Don Hansen