The Bailey Corporation, a manufacturer of medical supplies and equipment, is

planning to sell its shares to the general public for the first time. The firm's
investment banker, Robert Merrill and Company, is working with Bailey
Corporation in determining a number of items. Information on the Bailey
Corporation follows:
Bailey Corporation
Income Statement
For the Year 200X
Sales (all on credit)................................................................
Cost of goods sold..................................................................
Gross profit............................................................................
Selling and administrative expense........................................
Operating profit......................................................................
Interest expense......................................................................
Net income before taxes.........................................................
Taxes......................................................................................
Net income.............................................................................

$42,680,000
32,240,000
10,440,000
4,558,000
5,882,000
600,000
5,282,000
2,120,000
$ 3,162,000

Bailey Corporation
Balance Sheet
As of December 31, 200X
Assets
Current assets
Cash......................................................................................
Marketable securities...........................................................
Accounts receivable.............................................................
Inventory..............................................................................
Total current assets.............................................................
Net plant and equipment........................................................
Total assets.............................................................................

250,000
130,000
6,000,000
8,300,000
14,680,000
13,970,000
$28,650,000

Liabilities and Stockholders' Equity

Current liabilities:
Accounts payable.................................................................
Notes payable.......................................................................
Total current liabilities.......................................................
Long-term liabilities...............................................................
Total liabilities.......................................................................
Stockholders' equity:
Common stock (1,800,000 shares at $1 par)........................
Capital in excess of pare......................................................

$ 3,800,000
3,550,000
7,350,000
5,260,000
$12,970,000
$ 1,800,000
6,300,000

Retained earnings.................................................................
Total stockholders' equity..................................................
Total liabilities and stockholders' equity................................

7,580,000
15,680,000
$28,650,000

a. Assume that 800,000 new corporate shares will be issued to the general
public. What will earnings per share be immediately after the public
offering? (Round to two places to the right of the decimal point.) Based on
the price-earnings ratio of 12, what will the initial price of the stock be? Use
earnings per share after the distribution in the calculation.
b. Assuming an underwriting spread of 5 percent and out-of-pocket costs of
$300,000, what will net proceeds to the corporation be?
c. What return must the corporation earn on the net proceeds to equal the
earnings per share before the offering? How does this compare with current
return on the total assets on the balance sheet?
d. Now assume that, of the initial 800,000 share distribution, 400,000 belong
to current stockholders and 400,000 are new shares, and the latter will be
added to the 1,800,000 shares currently outstanding. What will earnings per
share be immediately after the public offering? What will the initial market
price of the stock be? Assume a price-earnings ratio of 12 and use earnings
per share after the distribution in the calculation.
e. Assuming an underwriter spread of 5 percent and out-of-picket costs of
$300,000, what will net proceeds to the corporation be?
f. What return must the corporation now earn on the net proceeds to equal
earnings per share before the offering? How does this compare with current
return on the total assets on the balance sheet?

a. Earnings per share (after)

$3,162,000
1,800,000 800,000

Earnings
Shares

$3,162,000
$1.22
2,600,000

Initial market price

= P/E * EPS
= 12 * $1.22 = $14.64

b. 800,000 shares * $14.64

= $11,712,000 gross proceeds

585,600 5% spread
300,000 out-of-pocket costs
$10,826,400 net proceeds

c. Earnings per share (before)

Earnings
Shares

$3,162,000
$1.76
1,800,000
In order to earn $1.76 after the offering, the return on $10,826,400 must
produce new earnings equal to X.
$3,162,00 X
$1.76
1,800,000 800,000
$3,162,000 X
$1.76
2,600,000
$3,162,000 + X = $1.76 (2,600,000)

X = $4,576,000 $3,162,000
X = $1,414,000
Proof:
$3,162,000 $1,414,000
1,800,000 800,000
thus :

New earnings
New proceeds

$4,576,000
$1.76
2,600,000

$1,414,000
13.06%
$10,826,400

The firm must earn 13.06% on net proceeds to equal earnings per share before
the offering.
This is greater than current return on assets of 11.04%.
Net income
$3,162,000

11.04%
Total assets $28,650,000

d. Earnings per share (after)

Earnings
Shares

$3,162,000
$3,162,000

$1.44
1,800,000 400,000 2,200,000
Initial market price = P/E * EPS
12 * $1.44 = $17.28.
e. 400,000 * $17.28 =

$6,912,000

gross proceeds

 345,600
300,000
$6,266,400

f.

5% spread
out-of-pocket costs
net proceeds

$3,162,000 X
$1.76
1,800,000 400,000
$3,162,000 X
$1.76
2,200,000
$3,162,000 X $1.76 (2,200,000)
X = $3,872,000 $3,162,000
X = $710,000
proof:
$3,162,000 $710,000 $3,872,000

$1.76
1,800,000 400,000
2,200,000

thus:
New earnings
$710,000

11.33%
Net proceeds $6,266,400

This is greater than the current return on assets of 11.04%.

Net income
$3,162,000

11 .04%
Total assets $28,650,000