immediate dilution?

Question

1. 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?

Answer 1

First, the $9 million in earnings is for the 5 million shares already outstanding.

Second, the immediacy of the dilution is realized by the stockholders that will be unable to subscribe to their proportional share percentage. If I owned 1 million, then in order to sustain my proportional share, I would need to buy 200 thousand of the new shares offered. If I did not or could not, then my interest is diluted.

The intrinsic dilution of the stock value will depend on the pre-issue valuations. Are you talking about an 11 percent price to earnings ratio or what? If the story is simply that the company made $9 million among 5 million shares, then the earnings per share is $1.80. When you add a million shares and in your example you also add $40 million to the asset value--we don't know what the previous asset value is. Nonetheless, what that $40 million plus previous asset value earns is the next issue--that earnings will be divided by 6 million shares, not 5 million. The dilution issue then is if the earnings per share will have been less under the new valuation than if there had not been made.

If you are then saying that the company will only earn $9 million even though it has an extra $40 million in new capitalization and that $9 million is divided among 6 million shares, instead of 5 million, then the new earnings per share is $1.50. So the dilution of earnings is 40 cents per share. But consider too if the company capitalization was, say, a dollar a share earlier, as in the company's founding, and the $5 million asset base had grown so that the company now was earning $9 million off of it, then adding $40 million to the asset base leads one to find no dilution in book value. With a previous $5 million, plus $40 million of fresh money, then the company has an asset base of at least $45 million (plus whatever retained earnings or such may have swollen the company's coffers in the meanwhile). That is $1 per share suddenly swelling to $7.50 per share book value with the new stock issue. So if the value of the share of earnings falls, the value of the equity rises. See, there are a few things outside your picture that affect, or could affect, the drawing of conclusions, and I've just hinted at a few of many.

Answer 2

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Answer 3

Dilution Potential

Answer 4

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Answer 5

The dilution is 20%

The price of the offering will be at whatever the company directs it to be, and buyers will decide if they are interested.
But to offer it for sale above the current share price, will result in no buyers unless the is an inclusion of warrants to sweeten the deal.
(Warrants are rights to by another share at a certain price until a defined time in the future)

Answer 6

1

Answer 7

a.

current eps = $9m/5m = $1.8

diluted eps = $9/6m = $1.5

effect = $0.3 reduction

b.

$40m*0.11 = $4.4m

return per new share $4.4m/1m = $0.44

new eps = (£9m + $4.4m)/6m = $2.23

thus new eps $2.23 > original eps $1.8

they should release the new issue

hope this helps

Answer 8

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