Share Repuchase Using Borrowed Funds

Ok, I’m losing my mind and can’t figure out how to solve this question. It’s from CFAI book under Corp Fin pg.173. Specifically, I am having problems determining the earnings and # of shares outstanding in order to calculate EPS after the buyback. Anyone know? Thanks. Jensen Industries plans to borrow \$12 million which it will use to repurchase shares. The following information is given: -Share price at time of buyback: \$50 -EPS before buyback = \$3 -Earnings yield (E/P) = \$3/60 = 5% -After Tax cost of borrowing = 5% -Planned buyback: 200,000 shares Calculate the EPS after the buyback. — Answer: EPS after buyback = Earnings - After tax cost of funds / Shares o/s after buyback. =\$6.6 million - (200,000 shares*\$60*0.05) / 2.0 million shares =\$6.6 million - \$0.6 million / 2.0 million shares =\$3.0 when aftertax cost of borrowing = earnings yield of the shares, the share repurchase has no effect on the company’s EPS.

xavier1, did you miss the number of shared outstanding information?

i dont think you can solve it without the shares outstanding

actually when A/T Cost of borrowing = Earnings Yield ==> You do not need to do any calculation. EPS before buyback = EPS after buyback. It is in the middle of the chapter somewhere, (in very light ink… not bolded at all).

makes sense i didn’t understand where the 2 mil shares came from though

I am missing my entire book 4 from the CFAI texts (do not know where it has disappeared to). Probably this is part of a multipart problem?

What does it mean? 200,000 shares*\$60*0.05

that’s all the info that was given. i thought we needed the # shares o/s or earnings to solve for one or the other. ok, i get that since a/t cost of borrowing = earn yield, then eps will be the same. i was just trying to figure it out w/ the formula in case the exam gives a couple parts and we have to solve for the others. i thought maybe we could deduce earnings and/or shares outstanding from the info given and i was just missing the concept. the 200,000 shares*\$60*0.05 is the cost of funds. 200,000*60 is the amount you need to borrow to buyback the shares given \$60 share price in the market. then * by 5% after tax cost of borrowing. i’ll go back to the book and see if it’s part of a multi-part problem, but i don’t think it is.

Ok 12 mlns*5% Interest Expense (tax adjusted)

The problem as presented is complete. However is doesn’t test the actual LOS (the LOS asks for what happend when a/t cost to borrow is above (below) the earnings yield). [Study Session 11-50-c] 1. The original number of shares is irrelevant FOR THIS PROBLEM only because the a/t cost of borrowing equals the earnings yield. Because they are equal a repurchase will have no effect, so # shares is irrelevant. Normally for these problems the number of shares IS relevant because you need it to recalculate EPS after the buyback (when the a/t cost if above or below the earnings yield) 2. The \$12MM is irrelevant in this problem as well. Normally this information IS relevant because by combining the total borrowing with number of shares repurchased you can find the price at which they were purchased. This price would then allow you to find the total a/t cost of borrowing. This problem is very similar to one on at least one of the CFAI practice exams (Exam 2, problem 39). Let’s try the above problem with the additional information: - original number of shares o/s is 1,100,000 - a/t cost of borrowing = 7% - find the new EPS, show your calculations

In the answer given in the original post above, where did the figure of \$6.6 million for earnings come from?

In CFAI example problems of this type (in my experience) there are always a total number of shares equal to 11x the repurchase. So in this case a repurchase of 200,000 means an initial share count of 2,200,000. EPS = \$3, so E = 3*2,200,000 = \$6,600,000. …or so I assume. I don’t have the original question.

In the problem mentioned at the beginning, can some one clarify my understanding. -Share price at time of buyback: \$50 -Earnings yield (E/P) = \$3/60 = 5% The denominator in Earnings yield ratio is \$60, where as the share price mentioned at time of buyback is \$50. Is \$60 the book value where as the market price is \$50? mkgref wrote : >Let’s try the above problem with the additional information: >- original number of shares o/s is 1,100,000 >- a/t cost of borrowing = 7% >- find the new EPS, show your calculations -Share price at time of buyback: \$50 -EPS before buyback = \$3 -Earnings yield (E/P) = \$3/60 = 5% -After Tax cost of borrowing = 7% -Planned buyback: 200,000 shares -original number of shares o/s is 1,100,000 Since A/T cost of borrowing is greater than Earnings yield, EPS goes down. EPS after buyback = (3.3m - 12m * 0.07) / 0.9 m = 2.73