EPS After Repurchase

CFA Level II
#1

I have seen the trend that if the after tax cost of borrowing is greater than the Earnings Yield (E/P), then the EPS after share repurchase drops. If cost of borrowing = E/P, EPS stays the same, and the oppostive above if cost of borrowing is lower. My question: is this always the case? or are there other factors I am missing that can make this different - -

#2

makes sense, could be a nice shortcut

#3

this question sums it up more or less: The CFO of Oxy Company has considered recommending a share repurchase funded through debt borrowings. The market value of the stock currently exceeds the book value per share, and the after-tax cost of borrowing exceeds the earnings yield on the stock. Assuming the company completes the repurchase: a. Book value per share and EPS will increase. b. Book value per share will increase and EPS will decrease. c. Book value per share and EPS will decrease. Choice “c” is correct. Book value per share decreases when a firm repurchases shares with market value greater than book value. Earnings per share will decrease when the after-tax cost of debt exceeds the earnings yield. so in share repurchases, if MV > BV, BVPS down After Tax Borrow > E/P, EPS down

#4

Correct. I had a convo with my friend over the weekend and they never discuss what happens if a company uses cash to fund the purchase. I guess that’s not the usual situation. If cash were used EPS should go up.

#5

> they never discuss what happens if a company uses cash to fund the purchase The question is really whether the cash is surplus. If not surplus (the usual case), then even if they use cash today to repo shares, they’ll ultimately need to take on new debt to replace the cash. If it’s surplus cash: why is it in the company in the first place? So this situation is a little unusual – the general academic assumption is that companies don’t carry surplus cash (because that doesn’t-add-to/destroys shareholder value). But if you’re modeling it anyway – at a minimum in valuing the transaction, remove the interest income they’re getting on it.

#6

Thanks DH, that makes sense.

#7

DarienHacker Wrote: ------------------------------------------------------- > > they never discuss what happens if a company > uses cash to fund the purchase > > The question is really whether the cash is > surplus. If not surplus (the usual case), then > even if they use cash today to repo shares, > they’ll ultimately need to take on new debt to > replace the cash. > > If it’s surplus cash: why is it in the company in > the first place? So this situation is a little > unusual – the general academic assumption is that > companies don’t carry surplus cash (because that > doesn’t-add-to/destroys shareholder value). > > But if you’re modeling it anyway – at a minimum > in valuing the transaction, remove the interest > income they’re getting on it. Unless you are ExxonMobil. Then you are too fxcking large to find anything worth reinvesting your cash flows; prospective project investments do not exceed the opportunity cost of buying back stock. So you buy back shares.