Response to the following problem:
Monahans Corporation is well positioned. Located in Tucson, Arizona, Monahans is the only company between Texas and California with reliable sources for its imported gifts. The company does a brisk business with specialty stores such as Pier 1 Imports. Monahans' recent success has made the company a prime target for a takeover. An investment group from Hong Kong is attempting to buy 51% of Monahans' outstanding stock against the wishes of Monahans' board of directors. Board members are convinced that the Hong Kong investors would sell the most desirable pieces of the business and leave little of value.
At the most recent board meeting, several suggestions were advanced to fight off the hostile takeover bid. The suggestion with the most promise is to purchase a huge quantity of treasury stock. Monahans has the cash to carry out this plan.
Required:
1. As a significant stockholder of Monahans Corporation, write a memorandum to explain to the board how the purchase of treasury stock would make it difficult for the Hong Kong group to take over Monahans. Include a discussion of the effect that purchasing treasury stock would have on stock outstanding and on the size of the corporation.
2. Suppose Monahans management is successful in fighting off the takeover bid and later sells the treasury stock at prices greater than the purchase price. Explain what effect these sales will have on assets, stockholders' equity, and net income.