Newdex has net income of $3,000,000 (INCLUDING the effect of expected underwriting costs) and 1,000,000 shares outstanding. It needs to raise $5,000,000 in funds for a new asset. Its investment banker plans to sell an issue of common stock to the public for $40, less a spread of 10%. How much must Newdex's after-tax income increase by to prevent dilution of earnings per share?

Question

Quizplus · Accepted Answer

Newdex needs to sell 125,000 new shares to raise $5,000,000 ($5,000,000 ÷ $40 = 125,000 shares). The investment banker's spread is 10%, so Newdex will receive $36 per share ($40 x (1-10%) = $36 per share). Newdex's total proceeds will be $4,500,000 ($36 x 125,000 shares).

Before the new share issue, earnings per share (EPS) is $3 ($3,000,000 ÷ 1,000,000 shares outstanding).

If Newdex does not increase its after-tax income, EPS will decrease to $2.66 ($3,000,000 ÷ 1,125,000 total shares outstanding after the new share issue).

To prevent dilution of EPS, Newdex needs to increase after-tax income by $416,667 (($3/share - $2.66/share) x 1,125,000 total shares outstanding after the new share issue). Therefore, the correct answer is B.

Newdex Has Net Income of $3,000,000 (INCLUDING the Effect of Expected