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.

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?

Short answer

The EPS has increased due to the investment made in the new facility and this has benefitted by the shareholders. The EPS can be increased by increasing the company’s earnings and also by buying-back the shares and reducing the outstanding shares.

Step-by-step solution

Impact of sale of stock and investment on shareholders

The investment made by the company due to the sale of shares has resulted in an increase in the earnings per share of the company. The increased EPS will benefit the shareholders as it will result in an increase in their earnings.

Financing strategy that the company could have used

The company can use the following financing strategy for increasing its EPS:

1. Increasing the company’s net earnings: The increase in net earnings will also help in improving the company’s earnings per share.
2. The buy-back of shares will help in reducing the number of outstanding shares which will result in an increase in company’s earnings per share.