Company ABC plans to borrow $10 million, which is will use to purchase 100,000 of their 1,100,00 shares currently outstanding. The following information is available: Share price at the time of the buyback: $40 EPS before the buyback: $4 Earnings Yield: 10% After tax cost of borrowing: 6% EPS after the stock buyback will be closest to: A $3.76 B $4.00 C $4.16 D $4.40
C, EPS = NI/Oustanding shares, NI goes down less than outstanding shares , and hence I took guess between C & D.,
Is this question incomplete or incorrectly copied? They borrow $10MM however, only use $4MM to buyback stock…what do they do with the remaining $6MM?? EPS = (4,400,000)-(600,000) / 1,000,0000 = $3.80 so A?
Answer is C
can you please show calculation? Thanks!
My guess: NI=4.4mil Deduct aftertax cost of debt, but only the debt used in repurchase: 0.06*4mil=0.24mil New EPS=(4.4-0.24)/1=4.16
map1 - you still have to pay the interest expense and it flows through your income statement so I don’t understand why you would just use the portion used to buyback stock. Unless you had a $10MM line of credit and only drew $4MM to buyback stock. Or, you used the rest of the $6MM for other projects. Thus, why I asked if the question is missing any information. There is no way the pro forma EPS after stock buyback of $4.16 should be higher than the actual EPS of $3.80.