where did they get the 56 million in earnings from which is listed in the answer? thanks, 1luv
I am also wondering where the 56 million in earnings came from. I’m not sure if schweser left something out or if I’m missing something obvious?
On a conceptual level this question is asking whether price to earnings ratio stays constant in both a special cash dividend and a share repurchase scenario. So even without doing any calculations you could intuit that the answer is probably no - p/e must change in at least one of the scenarios. To prove it, you accept as given that p/e is 20 before the transaction, and try to determine whether it has changed as result of either transaction. If p/e = 20, then price of a share (28$) divided by earnings per share must = 20 before either transaction. Therefore Earnings per share must equal $1.40 per share (solve for x where 28/x = 20) If there are 40 million shares then total earnings must equal 1.40 earnings per share times 40 million shares = 56 million. You then run through the effects of the dividend and the repurchase to determine if this changes. The point of the question is that the repurchase drives down number of shares, but keeps earnings constants, so that earnings per shares increase. If earnings per share increases, the the price to earnings ratio must change, even where price of stock in a repurchase stays constant.
Schweser actually posted a clarification regarding this exact question on its website that explains how you can back into the EPS. Check out the Errata section.