Newdex has net income of $3,000,000 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 to prevent dilution of EPS?
A) $40,000
B) $416,667
C) $350,000
D) None of these

Question

Quizplus · Accepted Answer

To raise $5,000,000, Newdex needs to sell 125,000 shares (5,000,000 / (40*(1-0.10))). After this offering, Newdex would have 1,125,000 shares outstanding (1,000,000 + 125,000).

To prevent dilution of EPS, Newdex's net income must increase by the amount of earnings that would be attributable to the 125,000 new shares issued.

Earnings per share (EPS) = Net Income / Number of Shares Outstanding

If Newdex's net income increased by $416,667 (125,000 shares x $40 price per share x (1-0.10 spread) / 1,125,000 total shares), then EPS would remain the same as before the offering ($3,000,000 net income / 1,000,000 shares = $3.00 EPS). Therefore, the answer is B.

Newdex Has Net Income of $3,000,000 and 1,000,000 Shares Outstanding