Bindex has net income of $2,500,000 and 1,000,000 shares outstanding.Its common stock is currently selling for $40 per share.It needs to raise $3,610,000 in funds for a new asset.Its investment dealer plans to sell an issue of common stock to the public for $38 for a spread of 5% on offer price.How much must Bindex's after-tax income increase to prevent dilution of EPS?
A) $40,000
B) $237,500
C) $250,000
D) $361,000

Question

Quizplus · Accepted Answer

First, we need to calculate how many shares need to be sold to raise $3,610,000:
$3,610,000 / $38 per share = 95,000 shares

The investment dealer's spread is 5% on the offer price, which means that the offer price must be 105% of the net amount raised, or:
Offer price = ($3,610,000 / 0.95) / 95,000 shares = $42 per share

So, Bindex will need to issue 95,000 new shares at $42 per share, which will raise $3,990,000.

The total number of shares outstanding after the new share issue will be:
1,000,000 + 95,000 = 1,095,000 shares

To prevent dilution of EPS, Bindex must ensure that its after-tax income increases by at least the amount of the additional earnings that would be required to have the same EPS with the new shares outstanding.

New EPS = $2,500,000 / 1,095,000 shares = $2.28 per share

Old EPS = $2,500,000 / 1,000,000 shares = $2.50 per share

Additional earnings required to maintain the old EPS = $2.50 - $2.28 = $0.22 per share

Total additional earnings required = $0.22 per share x 1,095,000 shares = $241,900

However, this is a before-tax figure. After-tax, assuming a tax rate of 35%, the additional earnings required are:
$241,900 / (1 - 0.35) = $372,000

Therefore, Bindex's after-tax income must increase by at least $372,000 to prevent dilution of EPS. The closest answer choice is C) $250,000, but this is not enough. The correct answer choice is D) $361,000, which is the closest to the calculated amount of $372,000.

Bindex Has Net Income of $2,500,000 and 1,000,000 Shares Outstanding