Question

Cross Town Cookies is an all-equity firm with a total market value of $765,000. The firm has 46,000 shares of stock outstanding. Management is considering issuing $188,000 of debt at an interest rate of 6 percent and using the proceeds to repurchase shares. Before the debt issue, EBIT will be $69,200. What is the EPS if the debt is issued? Ignore taxes.

Answer 1

The EPS is computed as shown below:

Current value per share is computed as follows:

= Total market value / Number of shares outstanding

= $ 765,000 / 46,000

= $ 16.63043478

Number of shares after repurchase is computed as follows:

= Current number of shares - Debt proceeds / Current value per share

= 46,000 - $ 188,000 / $ 16.63043478

= 34,695.42484 shares

EPS will be computed as follows:

= (EBIT - Amount of debt x interest rate) / Number of shares after repurchase

= ($ 69,200 - $ 188,000 x 6%) / 34,695.42484 shares

= $ 57,920 / 34,695.42484 shares

= $ 1.67 Approximately

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