Firm BUS106 now has 100,000 shares of common stock outstanding, and the total market value of equity equals $5,000,000. It also has an equal amount of debt. Firm BUS106 is expected to generate $1,500,000 in EBIT with a $250,000 of interest expense. Assume tax rate is 0, what will happen to earning per share (EPS) if firm BUS106 buys back $2,500,000 of shares, and the firm substitutes an equal amount of additional debt

EPs befor buy-back 12.5

afer buy-back 22.5

Explanation:

current earning per share:

EBIT - interest - taxes = ent income

1,500,000 - 250,000 - 0 = 1,250,000

shares outstanding 100,000

EPS BEFORE BUY-BACK

EPS12.5

After buyback:

the company is buying 2,500,000 /5,000,000 = 50% of the shares

thus it wil drop from 100,000 to 50,000

Now, we solve for the additional interest expense using cross multiplication:

5,000,000 of debt generate 250,000 iunterest

so 2,500,000 will do 250,000 / 5,000,000 x 2,5000,000 = 125,000

Now we solve for net income:

1,500,000 EBIT - 250,000 orignal interest - 125,000 addional= 1,125,000

Last step new EPS

EPS22.5

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