Chapter 5: Q20BP (page 601)

Question: Worst Buy Company has had a lot of complaints from customers of late, and its stock price is now only $2 per share. It is going to employ a one-for-five reverse stock split to increase the stock value. Assume Dean Smith owns 140 shares.
a. How many shares will he own after the reverse stock split?
b. What is the anticipated price of the stock after the reverse stock split?
c. Because investors often have a negative reaction to a reverse stock split, assume the stock only goes up to 80 percent of the value computed in part b. What will the stock’s price be?
d. How has the total value of Dean Smith’s holdings changed from before the reverse stock split to after the reverse stock split (based on the stock value computed in part c)? To get the total value before and after the split, multiply the shares held times the stock price.

Short Answer

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Answer

The shares held after reverse stock split is 28 shares.The anticipated stock price after stock split will be $10.The anticipated stock price after stock split based on 80% assumption will be $8.The value of holding before stock split is $280 and after stock split will be $224.

Step by step solution

Calculation of shares held after reverse stock split

The shares held after reverse stock split is 28 shares.

$N u m b e r o f s h a r e s = \frac{S h a r e s h e l d}{R e v e r s e s p l i t r a t i o} = \frac{140}{5} = 28$

Calculation of anticipated stock price after stock split

The anticipated stock price after stock split will be $10.

$S t o c k p r i c e = O r i g i n a l s t o c k p r i c e \times R e v e r s e s p l i t r a t i o = $ 2 \times 5 = $ 10$

Calculation of anticipated stock price after stock split based on 80% assumption

The anticipated stock price before stock split will be $8.

$S t o c k p r i c e = A n t i c i p a t e d s t o c k p r i c e \times 80 % a s s u m p t i o n = $ 10 \times 80 % = $ 8$

Calculation of value of holding before and after stock split

The value of holding before stock split is $280 and after stock split will be $224.

$V a l u e o f h o l d i n g = S h a r e s h e l d \times s t o c k p r i c e = 140 \times $ 2 = $ 280 V a l u e o f h o l d i n g = S h a r e s h e l d \times s t o c k p r i c e = 28 \times $ 8 = $ 224$

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Assets
	Book value	Liquidation value
Accounts receivables	\(1,400,000	\)1,200,000
Inventory	\(1,800,000	\)900,000
Machinery and equipment	\(1,100,000	\)600,000
Building and plant	\(4,200,000	\)2,500,000
Total assets	\(8,500,000	\)5,200,000

Liabilities and stockholder’s claims
Liabilities
Accounts payable	\(2,800,000
First lien, secured by machinery and equipment	\)900,000
Senior unsecured debt	\(2,200,000
Subordinated debenture	\)1,700,000
Total liabilities	\(7,600,000
Stockholder’s claims
Preferred stock	\)250,000
Common stock	\(650,000
Total stockholder’s claims	\)900,000
Total liabilities and stockholder’s claims	$8,500,000

Bailey corporation
Income statement
For the year 20X1
Sales (all on credit)	\(42,680,000
Cost of goods sold	\)32,240,000
Gross profit	\(10,440,000
Selling and administrative expenses	\)4,558,000
Operating profit	\(5,882,000
Interest expense	\)600,000
Net income before taxes	\(5,282,000
Taxes	\)2,120,000
Net income	\(3,162,000

Bailey corporation
Balance sheet
As of December 31, 20X1
Assets
Current assets:
Cash	\)250,000
Marketable securities	\(130,000
Accounts receivables	\)6,000,000
Inventory	\(8,300,000
Total current assets	\)14,680,000
Net plant and equipment	\(13,970,000
Total assets	\)28,650,000
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	\(3,800,000
Notes payable	\)3,550,000
Total current liabilities	\(7,350,000
Long-term liabilities	\)5,620,000
Total liabilities	\(12,970,000
Stockholder’s equity:
Common stock (1,800,000 shares at \)1 par)	\(1,800,000
Capital in excess of par	\)6,300,000
Retained earnings	\(7,580,000
Total stockholder’s equity	\)15,680,000
Total liabilities and stockholder’s equity	$28,650,000

Assets
	Book value	Liquidation value
Accounts receivables	\(1,400,000	\)1,200,000
Inventory	\(1,800,000	\)900,000
Machinery and equipment	\(1,100,000	\)600,000
Building and plant	\(4,200,000	\)2,500,000
Total assets	\(8,500,000	\)5,200,000

Short Answer

Step by step solution

Calculation of shares held after reverse stock split

Calculation of anticipated stock price after stock split

Calculation of anticipated stock price after stock split based on 80% assumption

Calculation of value of holding before and after stock split

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