Question

Using the information in Problem 3, assume that American Health Systems’ 1,700,000 additional share can only be issued at $18 per share.

a. Assume that American Health Systems can earn 6 percent on the proceeds. Calculate earnings per share.

b. Should the new issue be undertaken based on earnings per share?

Short answer

a. Earnings per share is $1.4612.

b. No, the new issue should not be undertaken.

Step-by-step solution

Computation of earnings per share

$$\begin{gathered} Newincome=Expectedearnings\left(Additionalshares\times valuepershare\right) \\ =6\%\left(1,700,000\times \$18\right) \\ =\$1,836,000 \\ Totalincome=Newincome+Reportedearnings \\ =\$1,836,000+\$10,000,000 \\ =\$11,836,000 \\ NewEPS=\frac{Totalincome}{Outs\tan dingstock+Additionalissue} \\ =\frac{\$11,836,000}{6,400,000+1,700,000} \\ =\$1.4612 \end{gathered}$$

Undertaking of a new issue

$$\begin{gathered} EPSbeforestockissue=\frac{Earnings}{Outs\tan dingstock} \\ =\frac{\$10,000,000}{6,400,000} \\ =1.5625 \\ DecreaseinEPS=NewEPS-EPSbeforestockissue \\ =\$1.4612-\$1.5625 \\ =-\$0.1013 \end{gathered}$$

Conclusion: Hence, the new issue should not be undertaken because EPS will decrease by $0.1013.