Dagmar has 41,200,000 shares outstanding with a current market value of \$50 per share. Dagmar made 200m in profits for the recent quarter, ans since only 70% of these profits will be reinvested back into the company, the board is considering repurchasing \$60m worth of common stock. Dagmar assumes that the stock can be repurchased at the market price of \$50 per share. However, Dagmar decides to borrow \$60m that it will use to repurchase the shares. The CFO has compiled the following: - share price at the time buyback - \$50. - shares outstanding before buyback - 41,200,000 - EPS before buyback \$10 - Earnings yield = \$10 / \$50 = 20% - After tax cost of borrowing = 8% - Planned buyback = 1,200,000 Dagmar’s EPS after the repurchase of its common stock will be closest to: a) \$5.03 b) \$8.25 c) \$10.18 d) \$12.35

C: 10.18?

It seems to be C, but I am not sure that the tax charge should be taken in right away. It should go to deferred taxes, so no tax effect occurs immediately. That means the answer may not be C. Dreary

How come the EPS(before share re-purchase) is 10 when Earning is 200m and shareoutstanding is 41,200,000. Shouldn’t it be (200m/41.2m = \$4.85? The EPS (after share re-purchase) should climb up because the div. yield is greater than interest on debt . What am I missing then? Tks in advance.

EPS is annual.

dreary is this the way of calculating EPS before = 10, 41.2 M shares outstanding. Total earnings = 412 M Now post taking debt: Earnings = 412 - 60 * .08 = 40.72 M (Interest on 60 M @ 8 % deducted) # of shares = 41.2 - 1.2 = 40M New EPS = 40.72/ 40 = 10.18 Given the After tax cost of debt < Earnings Yield – BVPS will rise.

CPK…Thats the methodology that I used…I think you are golden.

Tks CPK. Now I got it.

nice work guys… it is answer C.

Now post taking debt: Earnings = 412 - 60 * .08 = 40.72 M (Interest on 60 M @ 8 % deducted) CPK123, that’s my question. The interest on the loan is due a year later, so I am not sure it should be taken out of earnings yet. May be so, but I think it should be added to deferred tax liabilities, and I am not sure when it is expensed. Can someone clarify? Dreary

Why would it matter when the interest is due? It would matter just when the loan is incurred I think I know what you are saying though, if they know the annual EPS that would mean that the accounting year is terminated so taking up a loan would influence next year’s net income but in the same time then the number of shares for calculating the EPS would not change. So I guess they are assuming all happens before year end. I’m not sure if I am right or not