ABC Inc. wants to diversify its operations. Some recent financial information fo
ID: 2784995 • Letter: A
Question
ABC Inc. wants to diversify its operations. Some recent financial information for the company is shown hereABC Inc. wants to diversify its operations. Some recent financial information for the company is shown here Stock price Number of shares 25,000 Total assets Total liabilities$200,000 Net income S60 $700,000 $480,000 ABC Inc. is considering an investment that has the same P/E ratio as the firm. The cost of the investment is $600,000 and it will be financed with a new equity issue. The return on the investment will equal ABC Inc.'s current ROE. Note: Please round your final answers to 2 decimal places. a) What is the number of new shares? Number of new shares shares b) What is the new EPS? New EPS = $ per share c) What is the new stock price? New stock price = $ d) What is the new book value per share? New book value per share = $ per share e) What is the new market to book ratio? New market-to-book = f) What is the NPV of the project? NPV = $
Explanation / Answer
Given Data:
Stock Price=$60, Number of Outstanding Shares= 25000. Net Income = $480000
Therefore, Market Value of Equity = No. of Outstanding Shares x Current Stock Price = 60 x 25000 =$1500000
Earnings per Share (EPS) = Net Income / No. of Outstanding Shares = 480000 / 25000 = $19.2
Total Assets =$700000 and Total liabilities =$200000.
Also , Total Assets = Total Liabilities + Book Value of Equity.
Therefore, Book Value of Equity = 700000-200000=$500000.
Return on Equity (ROE) = Net Income / Book Value of Equity = 0.96
Book Price per Share ( which is also the par value per share or new equity issuance price) = Book Value of Equity / No.of Outstanding Shares = 500000 / 250000 = $20
Existing PE Ratio = Price per Share / Earnings per Share = 60 / 19.2 =3.125
Cost of New Investment = $600000 (given)
a) To fund this Investment entirely using new equity ( with each share being issued at a book price of $20 each), number of additional shares to be issued = Cost of Investment / Price of each new share issued = 30000
b) Return on Investment = Existing ROE =0.96. Therefore, Investment's Net Income = ROE x New Investment Amount = 0.96 x 600000 = $576000.
Therefore, Total Net Income of the Company = Income from New Investment + Existing Net Income =480000 +576000 = $1056000
Total No. of Shares Outsanding after issuance of 30000 new shares = 55000
Therefore , firm's new EPS = 1056000 / 55000 =$19.2
c) New PE Ratio = Old PE Ratio = 3.125. New EPS =$19.2. Therefore, New Stock Price = $60
d) Book Value of Equity =$500000 + $600000, Total No. of Outstanding Shares =55000
Therefore, Book Value Per Share =1100000 / 55000 = $20