Reading 47: Dividends and Share Repurchases: Basics-LOS d 习 2011, company, compare, finance, center

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Session 11: Corporate Finance
Reading 47: Dividends and Share Repurchases: Basics

LOS d: Calculate and compare the effects of a share repurchase on earnings per share when 1) the repurchase is financed with the company's excess cash and 2) the company uses funded debt to finance the repurchase.

 

 

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.

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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.

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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) $3.18.

B) $3.23.

C) $3.32.

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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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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.

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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.