Chartered Financial Analyst Level 2
Get started today
Ultimate access to all questions.
- An analyst gathers the following information about a company that plans to issue new debt to repurchase shares:
- EPS before share repurchase: $3
- Market price per share at the time of repurchase: $40
- After-tax cost of new debt: 7%
As a result of the share repurchase, the company's EPS will:
Exam-Like
Community
LLeetQuiz
A
decrease.
B
not change.
C
increase.
Explanation:
Explanation
The EPS will increase because:
Key Calculation:
- Earnings yield = EPS / Price per share = 40 = 7.5%
- After-tax cost of debt = 7%
Analysis:
- The earnings yield (7.5%) exceeds the after-tax cost of debt (7%)
- This creates a positive spread of 0.5%
- When the earnings yield > cost of debt, share repurchases financed with debt will increase EPS
Concept:
- The company is essentially borrowing at 7% to buy assets (shares) that earn 7.5%
- This creates value and increases earnings per remaining share
- The reduction in shares outstanding combined with the positive spread leads to EPS accretion
Therefore, the share repurchase will increase EPS.
Comments
Loading comments...