Question

Cross Town Cookies is an all-equity firm with a total market value of $740,000. The firm has 46,000 shares of stock outstanding. Management is considering issuing $173,000 of debt at an interest rate of 9 percent and using the proceeds to repurchase shares. Before the debt issue, EBIT will be $66,200. What is the EPS if the debt is issued? Ignore taxes.

Multiple Choice

• $1.25

• $1.44

• $1.56

• $.98

• $1.66

Answer 1

Ans: Option B 1.44 , final calculation in point 7

(1) Total market value = $ 740,000

Number of share outstanding = 46,000

Market price of share = Total market value / Number of share outstanding

= $ 740,000 / 46000

= 16.087

(2) Debt proceeds = $ 173,000

(3) Number of share repurchased = Debt proceeds / Market price of share (REfer 1 and 2)

= $ 173,000 / 16.087

= 10,754

(4) Number of share outstaning after repurchase = shares outstaning -number of shares repurchased

= 46000 - 10754

= 35246

(5 Interest = Debt proceeds * interest rate

= $ 173,000* 9%

= $ 15,570

(6) Net INcome = EBIT - Interest) (Refer 5)

= $66,200 - $ 15,570

= $ 50,630

(7) EPS = Net income / number of share after repurchase

= $ 50,630 / 35246

= 1.436

= 1.44 option B