Question

Cross Town Cookies is an all-equity firm with a total market value of $710,000. The firm has 46,000 shares of stock outstanding. Management is considering issuing $155,000 of debt at an interest rate of 7 percent and using the proceeds to repurchase shares. Before the debt issue, EBIT will be $62,600. What is the EPS if the debt is issued? Ignore taxes.

rev: 06_14_2019_QC_CS-170956

Multiple Choice

• $1.56

• $1.26

• $1.44

• $.98

• $1.66

Answer 1

EPS if the debt is issued = $1.44

Step 1 - Calculate interest Amount from debt :-

Interest Amount = $155000 x 7% = $10850

Interest Amount = $10850

Step 2 - Calculate Net Profit :-

Net Proffit = EBIT - Interest Amount

Net Profit = $62600 - $10850

Net Profit = $51750

Step 3 - Calculate Current Share Price :-

Current Share Price = $710000 / 46000 shares

Current Share Price = $15.434783 Per Share

Step 4 - Calculate Shares Repurchased :-

Since entire Debt Proceeds of $155000 was used for Repurchase , Therefore :-

Shares Repurchased = Debt Proceeds of $155000 / Current Share Price

Shares Repurchased = $155000 / $15.434783

Shares Repurchased = 10043 Shares (Approx)

Step 5 - Calculate the number of shares outstanding after Shares Repurchased :-

Number of shares outstanding after Shares Repurchased = Existing shares outstanding - Shares Repurchased

Number of shares outstanding after Shares Repurchased = 46000 shares - 10043 Shares

Number of shares outstanding after Shares Repurchased = 35957 Shares

Step 6 - Calculate EPS :-

EPS = Net Profit / Number of shares outstanding after Shares Repurchased

EPS = $51750 / 35957 Shares

EPS = $1.44