Comprehensive problem Text Book Foundation of Financial Management
Electro Cardio Systems, Inc.
Dr. Robert Grossman founded Electro Cardio Systems, Inc, in 1972
The principal purpose of the firm was to engage in research and development of heart pump devices. Although the firm did not show a profit until 1997, by 2001 it reported after taz earnings of $1,200,000. The company had gone public in 1995 at $10 a share. Investors were initially interested in buying the stock because of its future prospects.
By year-end 2001, the stock was trading at $42 per share because the firm had made good on its produce lifesaving heart pump and, in the process, was now making reasonable earnings. With 850,000 shares outstanding, earning per share were $1.41.
Dr. Robert Grossman and the members of the board of directors were initially pleased when another firm, Parker Medical Products, began buyin their stock. John Parker, The chairman and CEO of Parker Medical Products, was though to be a shrewd investor and his company's purchase of 50,000 shares of ECS was taken as an affirmation of the success of the heart pump research firm.
However, when Parker bought another 50,000 shares, Dr. Grossman and members of the board of directors of ECS became concerned tha John Parker and his firm might be traying to take over ECS. Upon talking to his attorney, Dr. Grossman was reminded that ECS had a poison pill provision that took effect when any outside investor accumulated 25% or more of the shares outstanding. Current stockholders, excluding the potential takeover company. Were given the privilege of buying up to 500,000 new shares of ECS at 80% of current market value. Thus, the new shares would be restricted to friendly interests. The attorney also found that Dr. Grossman and "friendly" members of the board of directors currently owned 175,000 shares of ECS.
a) How many more shares would Parker Medical Products need to purchase before the poison pill provision would go into effect? Given the current price of ECS stock of $42, what would be the cost to Parker to get up to that level?
b) ECS's ultimate fear was that Parker Medical Prducts would gain over a 50 percent interest in ECS's outstanding shares. What would be the additional cost to Parker to get 50% (plus 1 share) of the stock outstanding of ECS at the current market price of ECS stock? In answering this question, assume Parker had previously accumulated the 25% position discussed in question a.
c) Now assume that Parker exceeds the number of shares you computed in part b and gets all the way uo to accumulating 625,000 shares of ECS. Under the poison pill provision, how many shares must "friendly" shareholders purchase to thwart a takeover attempt by Parker? What will be the total cost? Keep in mind that friendly interests already own 175,000 shares of ECS and to maintain control, they most own one more share than Parker.
d) Would you say the poison pill is an effective deterrent in this case? Is the poison pill in the best interest of the general stockholders ( those not associated with the company)?.