Question

The earnings per share (EPS) of a company decreased if the additional capital it wanted was obtained by issuing additional shares of stock. In at least three well composed paragraphs, please explain how this phenomenon comes about. Please also discuss how this decrease in EPS would affect a company’s decision whether to issue equity (shares of stock) or debt (a bond issue) for raising capital.

Answer 1

Issuing additional share of stocks decreases a company EPS. Earning per share is calculated as a company's profit divided by its outstanding shares. It is an indicator of the company's profitability. When a company issues additional shares to raise capital its EPS decreases as number of outstanding shares increase but company's profit remains unchanged.  

This results in share dilution i.e reduction in ownership proportion of the existing shareholders and hence decreses their voting power. This could have a negative impact on the shareholders and lead to drop in share price.

Issuing addition is not always negative because if the company is issuing the additional stocks to increase revenue, then this step could be positive. The purpose for raising aditional capital could be buying out a competitior, for a new venture or a new product line. This would overall have a favourable impact on EPS and share price in long term.

As a alternative company may issue debt to raise additional capital as creditors does not have a claim to equity in the business, and hence does not dilute the owner's ownership in the company. Creditors are only entitled to the repayment of the agreed-upon principal of the loan plus interest and has no direct claim on future profits of the business.