Compute diluted earnings per share

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Problem 1. Fondren Exploration, Ltd., has 1,000 convertible bonds (\$1,000 par value) outstanding, each of which may be converted to 50 shares. The \$1 million worth of bonds has 25 years to maturity. The current price of the stock is \$26 per share. The firm's net income in the most recent fiscal year was \$270,000. The bonds pay 12 percent interest. The corporation has 150,000 shares of common stock outstanding. Current market rates on long-term nonconvertible bonds of equal quality are 14 percent. A 35 percent tax rate is assumed.

a. Compute diluted earnings per share.

Problem 2. Worldwide Scientific Equipment is considering a cash acquisition of Medical Labs for \$1.5 million Medical Labs will provide the following pattern of cash inflows and synergistic benefits for the next 25 years. There is no tax loss carryforward.

Years
1-5 6-15 16-25
Cash inflow (aftertax) \$100,000 \$120,000 \$160,000
Synergistic Benefits (aftertax) 15,000 25,000 45,000

The cost of capital for the acquiring firm is 9 percent. Should the merger be undertaken?

Problem 3. General Meters is considering two mergers. The first is with Firm A its own volatile industry, the auto speedometer industry, wheras the second is a merger with firm B in an industry that moves in the opposite direction (and will tend to level out performance due to negative correlation).

a. Compute the mean, standard deviation, and coefficient of variation forboth investments.

Merge with Firm A
Possible Earnings (millions) Probablility
\$40................................. .30
\$50................................. .40
\$60................................. .30

Merge with Firm B
Possible Earnings (millions) Probablility
\$10................................. .25
\$50................................. .50
\$90................................. .25

b. Assuming investors are risk-averse, which alternative can be expected to bring the higher valuation?

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