Question

Walker Machine Tools has 6.5 million shares of common stock outstanding. The current market price of Walker common stock is $72 per share rights-on. The company’s net income this year is $22.50 million. A rights offering has been announced in which 650,000 new shares will be sold at $66.50 per share. The subscription price plus seven rights is needed to buy one of the new shares. a. What are the earnings per share and price-earnings ratio before the new shares are sold via the rights offering? (Do not round intermediate calculations and round your answers to 2 decimal places.) b. What would the earnings per share be immediately after the rights offering? What would the price-earnings ratio be immediately after the rights offering? (Assume there is no change in the market value of the stock, except for the change when the stock begins trading ex-rights.) (Do not round intermediate calculations and round your answers to 2 decimal places.)

Answer 1

(a) Earnings per share = Net income ÷ Number of shares

= $22,500,000 ÷ 6,500,000

= $3.46

Price-earnings ratio = Stock price ÷ Earnings per share

= $72 ÷ $3.46

= 20.81

(b) Earnings per share = Net income ÷ Number of shares

= $22,500,000 ÷ (6,500,000 + 650,000)

= $3.15

R = (M0 - S) ÷ (N + 1)

= ($72 - $66.50) ÷ (7 + 1)

= $0.69

where,

M0 = current market price of Walker common stock

S = selling price per share

N = seven rights is needed to buy one of the new shares

Ex-rights price = Rights-on price - Rights value

= $72 - $0.69

= $71.31

Price-earnings ratio = Stock price ÷ Earnings per share

= $71.31 ÷ $3.15

= 22.64