Question

Quisco Systems has 6.66.6 billion shares outstanding and a share price of $ 17.41 Quisco is considering developing a new networking product in house at a cost of $ 467

million.​ Alternatively, Quisco can acquire a firm that already has the technology for $ 939

million worth​ (at the current​ price) of Quisco stock. Suppose that absent the expense of the new​ technology, Quisco will have EPS of $ 0.82

a. Suppose Quisco develops the product in house. What impact would the development cost have on​ Quisco's EPS? Assume all costs are incurred this year and are treated as an​ R&D expense,​ Quisco's tax rate is 35% and the number of shares outstanding is unchanged.

b. Suppose Quisco does not develop the product in house but instead acquires the technology. What effect would the acquisition have on​ Quisco's EPS this​ year? (Note that acquisition expenses do not appear directly on the income statement.

Assume the firm was acquired at the start of the year and has no revenues or expenses of its​ own, so that the only effect on EPS is due to the change in the number of shares​ outstanding.)

c. Which method of acquiring the technology has a smaller impact on​ earnings? Is this method​ cheaper? Explain.

Answer 1

Important Note - No. of shares Outstanding are seams to be 6.66 billion or 6.6 billion (as there is an error in typing). Still I'm doing it taking both into consideration.

a). Quisco's product in house at a cost is $ 467 million

Since, all cost incurred during the year are treated as an R&D Expenses and are tax deductible.

Cost having Impact on EPS = $ 467 ( 1-35%) : = $ 303.55 million

i) As, the no. of shares outstanding are 6.66 billion, the impact it will have on EPS , i.e., decrease the EPS from

= $ 303.55 million / 6.66 billion

= $ 0.0456 per Share

So, the development cost will decrease Quisco's EPS from $ 0.82 to $ 0.7744 ($ 0.82-$0.0456).

ii) As, the no. of shares outstanding are 6.6 billion, the impact it will have on EPS , i.e., decrease the EPS from

= $ 303.55 million / 6.6 billion

= $ 0.0460 per Share

So, the development cost will decrease Quisco's EPS from $ 0.82 to $ 0.774 ($ 0.82-$0.0460).

b). If Quisco acquires the firm having technology for $939 million, it will buy it at its own current market price.

No. of new shares issued to acquire firm = $ 939 million /$ 17.41

= 53,934,520 shares

i) Earnings before Acquisition = $ 0.82 per share * 6.66 billion shares

= $ 5.4612 billion

EPS after acquisition = $ 5.4612 billion / ( 6,660,000,000 + 53,934,520) shares

= $ 5.4612 billion / 6,713,934,520 shares

= $ 0.8134 per share

So, effect the acquisition would have on​ Quisco's EPS this​ year is it will decrease from $ 0.82 per share to $ 0.8134 per share.

ii) Earnings before Acquisition = $ 0.82 per share * 6.6 billion shares

= $ 5.412 billion

EPS after acquisition = $ 5.412 billion / ( 6,600,000,000 + 53,934,520) shares

= $ 5.412 billion / 6,653,934,520 shares

= $ 0.8134 per share

So, effect the acquisition would have on​ Quisco's EPS this​ year is it will decrease from $ 0.82 per share to $ 0.8134 per share

c). Acquiring the new firm having technology will have smaller impact on earnings as compared to in house development. But it will not be cheaper as acquiring cost is way higher than that of in house development. Acquiring firm doesn't generate its income or expenses on its own and has led to increase the no. of outstanding shares while in house development has one time development cost which is expensed in Income statement decreasing EPS but its future income will increase EPS higher than that of acquiring scenario.

Hence, although aquiring new technology has small impact on EPS but it will not cheaper than that of in house Development.

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