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Dilution Potential - Louisiana Timber

Louisiana Timber Company currently has 5 million shares of stock outstanding
and will report earnings of $9 million in the current year. The company is
considering the issuance of 1 million additional shares that will net $40 per
share to the corporation.

a. What is the immediate dilution potential for this new stock issue?

b. Assume the Louisiana Timber Company can earn 11 percent on the
proceeds of the stock issue in time to include it in the current year's results.
Should the new issue be undertaken based on earnings per share?

c. if the one million additional shares can only be issued at $32 per
share and the company can earn 5 percent on the proceeds, should the new
issue be undertaken based on earnings per share?

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Solution Preview

a. The dilution potential is related to the reduction in the Earnings Per Share (EPS) of the firm. EPS is calculated by dividing the net income by the number of shares outstanding. The present EPS of the firm is 9/5=$1.8. The new issue will add 1 million addtional shares and ...

Solution Summary

The solution explains how to calculate the effect on EPS of a new stock issue