Karen Knox Exports, Inc., is located in Clancy, New Mexico. Knox is the only company with reliable sources for its imported gifts. The company does a brisk business with specialty stores such as Neiman Marcus. Knox’s recent success has made the company a prime target for a takeover. An investment group in Alberton is attempting to buy 52% of Knox’s outstanding stock against the wishes of Knox’s board of directors. Board members are convinced that the Alberton investors would sell the most desirable pieces of the business and leave little of value. At the most recent board meeting, several suggestions were advanced to fight off the hostile takeover bid. The suggestion with the most promise is to purchase a huge quantity of treasury stock. Knox has the cash to carry out this plan.

Requirements
1. Suppose you are a significant stockholder of Karen Knox Exports, Inc. Write a memorandum to explain to the board how the purchase of treasury stock would make it difficult for the Alberton group to take over Knox. Include in your memo a discussion of the effect that purchasing treasury stock would have on stock outstanding and on the size of the corporation.
2. Suppose Knox management is successful in fighting off the takeover bid and later sells the treasury stock at prices greater than the purchase price. Explain what effect these sales will have on assets, stockholders’ equity, and net income.