Question

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.

d. Compute the EPS and the price (P/E stays constant) after the new production facility begins to produce a profit.

Short answer

The EPS is $4.83 and the stock price is $48.83 after the new facility starts generating profit.

Step-by-step solution

Information available

Net income = $19,000,000

Shares outstanding = $4,000,000

Present selling price = $48 per share

ROI =13 %

Selling price for public issue = $44 per share

Spread = 4%

EPS = 10.1 times

Calculation of earnings of the company from the new facility

The earnings from the new facility is $2,745,600.

$\begin{array}{rcl}\mathrm{Additional}\mathrm{income}& =& \mathrm{ROI}\times \mathrm{Cost}\mathrm{of}\mathrm{new}\mathrm{facility}\\ & =& 13\%\times \$21,120,000\\ & =& \$2,745,600\end{array}$

Calculation of EPS after the new facility starts generating profit

The earnings per share is $4.83.

$\begin{array}{rcl}\mathrm{EPS}& =& \frac{\mathrm{Earnings}}{\mathrm{Stock}\mathrm{Outstanding}}\\ & =& \frac{\$19,000,000+\$2,745,600}{4,000,000+500,000}\\ & =& \$4.83\end{array}$

Calculation of stock price of the company after new facility starts generating profit

The stock price is $48.83.

$\begin{array}{rcl}\mathrm{Price}\mathrm{per}\mathrm{share}& =& \mathrm{PE}\times \mathrm{Earnings}\mathrm{per}\mathrm{share}\\ & =& 10.1\times \$4.83\\ & =& \$48.83\end{array}$