Teardrop, Inc., wishes to expand its facilities. The company currently has 8 million shares outstanding and no debt. The stock sells for $65 per share, but the book value per share is $20. Net income for Teardrop is currently $11.5 million. The new facility will cost $40 million, and it will increase net income by $600,000.
a. Assuming a constant price–earnings ratio, what will the effect be of issuing new equity to finance the investment? To answer, calculate the new book value per share, the new total earnings, the new EPS, the new stock price, and the new market-to-book ratio. What is going on here?
b. What would the new net income for Teardrop have to be for the stock price to remain unchanged?