Krugman Exports, Inc., is located in Clancy, New Mexico. The company does business with specialty stores such as Neiman Marcus. Krugman’s recent success has made the company a prime target for a takeover. The investment group Creston is attempting to buy 52% of Krugman’s outstanding stock against the wishes of Krugman’s board of directors. Board members are convinced that Creston would sell the most desirable pieces of the business and leave little of value. At the most recent board meeting, several suggestions for fighting off the hostile takeover were made. The one with the most promise is to purchase a huge quantity of treasury stock. Krugman has the cash to carry out this plan.

Requirements

1. Suppose you are a significant stockholder of Krugman Exports, Inc. Write a memorandum to explain to the board how the purchase of treasury stock would make it difficult for Creston to take over Krugman. Explain the effect that purchasing treasury stock would have on stock outstanding and on the size of the corporation.

2. Suppose Krugman 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.