Midland Corporation has a net income of $19 million and 4 million shares outstanding. Its common stock is currently selling for $48 per share. Midland plans to sell common stock to set up a major new production facility with a net cost of $21,120,000. The production facility will not produce a profit for one year, and then it is expected to earn a 13 percent return on the investment. Stanley Morgan and Co., an investment banking firm, plans to sell the issue to the public for $44 per share with a spread of 4 percent.
a. How many shares of stock must be sold to net $21,120,000?
b. Why is the investment banker selling the stock at less than its current market price?
c. What are the earnings per share (EPS) and the price-earnings ratio before the issue (based on a stock price of $48)? What will be the price per share immediately after the sale of stock if the P/E stays constant?
d. Compute the EPS and the price (if the P/E stays constant) after the new production facility begins to produce a profit.
e. Are the shareholders better off because of the sale of stock and the resultant investment? What other financing strategy could the company have tried to increase earnings per share?