LOS c: Calculate the earnings per share effect of a share repurchase when the repurchase is made with borrowed funds and the company's after-tax cost of debt is greater (less) than its earnings yield.

Q1. Pants R Us Inc.’s Board of Directors is considering repurchasing $30,000,000 worth of common stock. Pants R Us assumes that the stock can be repurchased at the market price of $50 per share. After much discussion Pants R Us decides to borrow $30 million that it will use to repurchase shares. Pants R Us’ Chief Investment Officer (CIO) has compiled the following information regarding the repurchase of the firm’s common stock:

• Share price at the time of buyback = $50
• Shares outstanding before buyback = 30,600,000
• EPS before buyback = $3.33
• Earnings yield = $3.33 / $50 = 6.7%
• After-tax cost of borrowing = 6.7%
• Planned buyback = 600,000 shares

Based on the information above, what will be Pants R Us’ earnings per share (EPS) after the repurchase of its common stock?

A)   $3.33.

B)   $3.28.

C)   $3.40.

Q2. Francis Investment Inc’s Board of Directors is considering repurchasing $30,000,000 worth of common stock. Francis assumes that the stock can be repurchased at the market price of $50 per share. After much discussion Francis decides to borrow $30 million that it will use to repurchase shares. Francis’ Chief Financial Officer (CFO) has compiled the following information regarding the repurchase of the firm’s common stock:

• Share price at the time of buyback = $50
• Shares outstanding before buyback = 30,600,000
• EPS before buyback = $3.33
• Earnings yield = $3.33 / $50 = 6.7%
• After-tax cost of borrowing = 4%
• Planned buyback = 600,000 shares

Based on the information above, after the repurchase of its common stock, Francis’ EPS will be closest to:

A)   $3.41.

B)   $3.39.

C)   $3.36.

Q3. Sinclair Construction Company’s Board of Directors is considering repurchasing $30,000,000 worth of common stock. Sinclair assumes that the stock can be repurchased at the market price of $50 per share. After much discussion Sinclair decides to borrow $30 million that it will use to repurchase shares. Sinclair’s Chief Executive Officer (CEO) has compiled the following information regarding the repurchase of the firm’s common stock:

• Share price at the time of buyback = $50
• Shares outstanding before buyback = 30,600,000
• EPS before buyback = $3.33
• Earnings yield = $3.33 / $50 = 6.7%
• After-tax cost of borrowing = 8.0%
• Planned buyback = 600,000 shares

Based on the information above, Sinclair’s earnings per share (EPS) after the repurchase of its common stock will be closest to:

A)   $3.32.

B)   $3.18.

C)   $3.23.

 LOS c: Calculate the earnings per share effect of a share repurchase when the repurchase is made with borrowed funds and the company's after-tax cost of debt is greater (less) than its earnings yield. fficeffice" />

Q1. Pants R Us Inc.’s Board of Directors is considering repurchasing $30,000,000 worth of common stock. Pants R Us assumes that the stock can be repurchased at the market price of $50 per share. After much discussion Pants R Us decides to borrow $30 million that it will use to repurchase shares. Pants R Us’ Chief Investment Officer (CIO) has compiled the following information regarding the repurchase of the firm’s common stock:

• Share price at the time of buyback = $50
• Shares outstanding before buyback = 30,600,000
• EPS before buyback = $3.33
• Earnings yield = $3.33 / $50 = 6.7%
• After-tax cost of borrowing = 6.7%
• Planned buyback = 600,000 shares

Based on the information above, what will be Pants R Us’ earnings per share (EPS) after the repurchase of its common stock?

A)   $3.33.

B)   $3.28.

C)   $3.40.

Correct answer is A)

Total earnings = $3.33 × 30,600,000 = $101,898,000

Since the after-tax cost of borrowing of 6.7%% is equal to the 6.7% earnings yield (E/P) of the shares, the share repurchase has no effect on Pants R Us’ EPS.

So the total wealth from owning one share will be $31.25 + $2.75 = $34.00.

If the company repurchases shares, it can buy $22 million/$34 = 647,058 shares. The value of one share would then be:

If you remember that both a cash dividend and a share repurchase for cash leave shareholder wealth unchanged, this question does not require calculations of the amounts.

Q2. Francis Investment Inc’s Board of Directors is considering repurchasing $30,000,000 worth of common stock. Francis assumes that the stock can be repurchased at the market price of $50 per share. After much discussion Francis decides to borrow $30 million that it will use to repurchase shares. Francis’ Chief Financial Officer (CFO) has compiled the following information regarding the repurchase of the firm’s common stock:

• Share price at the time of buyback = $50
• Shares outstanding before buyback = 30,600,000
• EPS before buyback = $3.33
• Earnings yield = $3.33 / $50 = 6.7%
• After-tax cost of borrowing = 4%
• Planned buyback = 600,000 shares

Based on the information above, after the repurchase of its common stock, Francis’ EPS will be closest to:

A)   $3.41.

B)   $3.39.

C)   $3.36.

Correct answer is C)

Total earnings = $3.33 × 30,600,000 = $101,898,000

Since the after-tax cost of borrowing of 4% is less than the 6.7% earnings yield (E/P) of the shares, the share repurchase will increase Francis’s EPS.

Q3. Sinclair Construction Company’s Board of Directors is considering repurchasing $30,000,000 worth of common stock. Sinclair assumes that the stock can be repurchased at the market price of $50 per share. After much discussion Sinclair decides to borrow $30 million that it will use to repurchase shares. Sinclair’s Chief Executive Officer (CEO) has compiled the following information regarding the repurchase of the firm’s common stock:

• Share price at the time of buyback = $50
• Shares outstanding before buyback = 30,600,000
• EPS before buyback = $3.33
• Earnings yield = $3.33 / $50 = 6.7%
• After-tax cost of borrowing = 8.0%
• Planned buyback = 600,000 shares

Based on the information above, Sinclair’s earnings per share (EPS) after the repurchase of its common stock will be closest to:

A)   $3.32.

B)   $3.18.

C)   $3.23.

Correct answer is A)

Total earnings = $3.33 × 30,600,000 = $101,898,000

Since the 8.0% after-tax cost of borrowing is greater than the 6.7% earnings yield (E/P) of the shares, the share repurchase reduces Sinclair’s EPS.

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