Question

XYZ Satellites Inc. is an all equity firm with 200,000 shares outstanding and $20 million in earnings after taxes with a market value of $350 million.The company borrows $75 million to repurchase#50000 shares @8%.The tax rate is 50%.
1) What effect will this have on the earning per share of the firm?
2) At what interest rate would have to be on the debt for the EPS effect to disappear?

Answer 1

1	EPS after repurchase	113.33
2	Interest rate to keep EPS same as 100	13.30%

	All Equity	Debt @8%+Equity	Formula
Market value	350,000,000
Earnings	20,000,000	17,000,000	Revised Earrnings = Earnings before Debt - Interest . Interest = 7500000*8%*0.5.
No of shares	200,000	150,000	50000 shares repurchased. So subtract this from initial no of shares
EPS	100	113
			Note: Interest has Tax benefit @ 50%
	All Equity	Debt @13.3%+Equity	Formula
Market value	350,000,000
Earnings	20,000,000	15,012,500	Revised Earrnings = Earnings before Debt - Interest . Interest = 7500000*8%*0.5.
No of shares	200,000	150,000	50000 shares repurchased. So subtract this from initial no of shares
EPS	100	100
			Note: Interest has Tax benefit @ 50%