Nogales Corporation is positioned ideally in its business. Located in Yuma, Arizona, Nogales 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. Nogales's recent success has made the company a prime target for a takeover. An investment group from Toronto is attempting to buy 51 percent of Nogales's outstanding stock against the wishes of Nogales's board of directors. Board members are convinced that the Toronto 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. Nogales has the cash to carry out this plan.

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1. As a significant stockholder of Nogales Corporation, write a memorandum to explain for the board how the purchase of treasury stock would make it more difficult for the Toronto group to take over Nogales. Include in your memo a discussion of the effect that purchasing treasury stock would have on stock outstanding and on the size of the corporation.

2. Suppose Nogales 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.