Question

XYZ Company has currently $2 million shares of common stock outstanding, and the
selling price of each stock is $25. They want to extend $3 Million through bond issuance
at 10% interest rate. Financial analyst estimated $2 Million EBIT. The marginal tax rate
is 35%.

a) What would be the earning per share?

Answer 1

Solution:

The formula for calculating the Earnings per share is

= [ ( EBIT – Interest Expense ) * ( 1 – Tax rate ) ] / No. of shares of common stock outstanding

As per the information given in the question we have

EBIT = $ 2,000,000 ; Tax rate = 35 %   ; No. of shares of common stock outstanding = 2,000,000   ;

Total value of bonds issued = $ 3,000,000 ; Interest rate on bonds = 10 %   ;  

Thus Interest Expense = Total value of bonds issued * Interest rate on bonds

= $ 3,000,000 * 10 % = $ 300,000

Applying the above information in the formula we have Earnings per share as

= [ ( $ 2,000,000 - $ 300,000 ) * ( 1 - 0.35 ) ] / 2,000,000

= [ ( $ 1,700,000 ) * ( 1 – 0.35 ) ] / 2,000,000

= [ $ 1,700,000 * 0.65 ] / 2,000,000

= $ 1,105,000 / 2,000,000

= $ 0.5525

= $ 0.55 ( when rounded off to two decimal places )

Thus the Earnings per share of XYZ Company is = $ 0.55