Question

Quisco Systems has 6.3 billion shares outstanding and a share price of $ 18.81. Quisco is considering developing a new networking product in house at a cost of $ 513 million.? Alternatively, Quisco can acquire a firm that already has the technology for $ 963 million worth? (at the current? price) of Quisco stock. Suppose that absent the expense of the new? technology, Quisco will have EPS of $ 0.96. 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

Solution:

Quisco Systems  

shares outstanding =  6.3 billion

Share price = $ 18.81

EPS = 0.96

Total earning = EPS * Total number of share = 0.96 * 6.3 billion = $6.048 billion

So the company can choose between 2 options

1. Invest $513 million and develop its own technology. In this way, the company is incurring this $513 million as R&D cost. Tax rate = 35%

So the company's earning will reduce by $513,000,000 * ( 1- tax rate ) = $513,000,000 * ( 1- 0.35 ) = 333,450,000

New earnings = Old earning - reduction in earning due to R&D = 6,048,000,000 -  333,450,000 = 5,714,550,000

new EPS = Earning / total share = 5,714,550,000 / 6,300,000,000 = 0.907071429 = 0.91

Option 2: Acquire the firm with the technology at 963 million

Since it is given that aquisition is done based on the current stock price at 18.81 and earning will remain same

So total no of shares at 18.81 to aquire the firm at 963 million  

= 963,000,000 / 18.81 = 51,196,172.25

So new total shares = Old share + new shares = 6,300,000,000 + 51,196,172.25 = 6,351,196,172

It is given that earning will remain same so Earnings =  6,048,000,000

EPS = Earning / total new shares =  6,048,000,000 / 6,351,196,172 = 0.9522

So , we can see that Old EPS is 0.96 and aquisition of the firm for 963 million has lower impact on EPS as in this case EPS is 0.9522 as compared to developing in house technology where EPS will be 0.91

Yes, this method is cheaper as it is having less impact on the earnings of the company.