Question

Quisco Systems has 7.1 billion shares outstanding and a share price of $17.38. Quisco is considering developing a new networking product in house at a cost of $455 million.​ Alternatively, Quisco can acquire a firm that already has the technology for $913 million worth​ (at the current​ price) of Quisco stock. Suppose that absent the expense of the new​ technology, Quisco will have EPS of $0.86.

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

25%​,

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

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