Two textile companies, Meyer Manufacturing and Haugen Mills, began operations with identical balance sheets. One year later, both required additional manufacturing capacity, which could be obtained by purchasing a new machine for $200,000. To raise the needed funds, Meyer issued a five-year, $200,000 bond with a coupon rate equal to 8 percent. Haugen, on the other hand, decided to sell common stock to raise the $200,000. The stock was sold for $50 per share, and the issue increased the number of outstanding, or existing, shares by 20 percent from the pre-issue level. All previous issues of stock were sold for $50 per share also. The balance sheet for each company, before the asset increases, is as follows:

a. Show the balance sheet of each firm after the asset is purchased.
b. How many shares of stock did Haugen have outstanding before the equity issue? How many are outstanding after the issue?
c. With the additional manufacturing capacity provided by the machine, the operating earnings (before taxes and interest payments) of each company will increase by $100,000. How much of this amount could be paid to the shareholders of each company? Assume that the tax rate for both companies is 40 percent.
d. How much of the $100,000 operating earnings could be paid as dividends to each share of stock for each company (i.e., the additional earnings per share)? Assume that both companies had the same number of outstanding shares of stock prior to the purchase of the newmachine.

  • CreatedNovember 24, 2014
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