COMPREHENSIVE PROBLEM
Dr. Paige Webb founded Portable Laptop, Inc., (PLI) in 1989. The principal purpose of the firm was to engage in the research and development of laptop computers. Although the firm did not show a profit until 1995, by 1999 it reported aftertax earnings of $2.4 million.
The company went public in 1993 at $20 a share. Investors were initially interested in buying the stock because of the firm- future prospects. By year-end 2003, the stock was trading at
$82 per share because the firm had made good on its promise to produce highly efficient laptop computers and, in the process, was making reasonable earnings. With 1.7 million shares outstanding, earnings per share were $1.41.
Dr. Webb and the members of the board of directors were initially pleased when another firm, Rom Scientific Computers Inc., began buying their stock. John Rom, the chairman and CEO of Rom Scientific Computers, was thought to be a shrewd investor and his company- purchase of 100,000 shares of PLI was taken as an affirmation of the success of the firm.
However, when Rom bought another 100,000 shares, Dr. Webb and members of the board of directors of PLI became concerned that John Rom and his firm might be trying to take over PLI. Upon talking to her attorney, Dr. Webb was reminded that PLI had a poison pill provision that would take effect when any outside investor accumulated 25 percent or more of the shares outstanding. Current stockholders, excluding the potential takeover company, could be given the privilege of buying up to 1,100,000 shares of PLI at 80 percent of current market value. Thus, new shares would be restricted to friendly interests.
The attorney also found that Dr. Webb and “friendly†members of the board of directors currently owned 350,000 shares of PLI.
a. How many more shares would Rom Scientific Computers need to purchase before the poison pill provision would go into effect? Given the current price of $82 for PLI stock, what would be the cost to Rom to get up to that level?
b. PLI- ultimate fear is that Rom Scientific Computers will gain over a 50 percent interest in PLI- outstanding shares. What would be the additional cost to Rom to acquire 50 percent (plus 1 share) of the stock outstanding of PLI at the current market price of PLI- stock? In answering this question, assume Rom had previously accumulated the 25 percent position discussed in part a.
c. Now assume Rom exceeds the number of shares you computed in part b and accumulates up to 1,250,000 shares of PLI. Under the poison pill provision, how many shares must “friendly†shareholders purchase to thwart a takeover attempt by Rom? What will be the total cost? Keep in mind that friendly interests already own 350,000 shares of PLI and to maintain control, they must own one more share than Rom.
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)?
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