Question

Quisco Systems has 6.4 billion shares outstanding and a share price of $ 17.65. Quisco is considering developing a new networking product in house at a cost of $ 528 million.​ Alternatively, Quisco can acquire a firm that already has the technology for $ 968 million worth​ (at the current​ price) of Quisco shares. Suppose that absent the expense of the new​ technology, Quisco will have EPS of $ 0.63. 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 30 %​, 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 acquired firm 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

Particulars	Self - Development	Acquisition
Pre- Acquisition EPS	0.63	0.63
Number of shares O/s	6400 Millions shares	6400 Million Shares
Earning for Equity	4032	4032
Tax Rate	30%	30%
Earning before tax(Equity Earning/(1-tax rate))	5760	5760
Less: Research & Development costs	(528)	nil
Earning before tax	5232	5760
Less: Tax @ 30%	(1569.60)	(1728)
Earning for Equity	3662.40	4032
Number of shares O/s:
Original Shares	6400	6400
Issued to QUISCO @ $17.65/share	nil	54.84
Total Share O/s	6400	6454.84
Earning per share	0.572	0.625

hence the mode by acquiring the company has least impact on the EPS of the company.

Computation of Total outflow under both options:

Particulars	Self Development	Acquisition
Cash Outflow	528	968
Less: Tax saving	(158.40)	nil
Net cash outflow	369.40	968

Since the net cashflow under Self-Development is cheaper than Acquisition, hence Self development is more cheaper.