Question

You are the CEO of Company A, an all-equity firm. Company A expects to generate earnings before interest and taxes (EBIT) of $100 million over the next year. Currently, Company A has 50 million shares outstanding, and its share price is $7.50. You plan to raise $150 million from the bank at an annual interest rate of 8% to repurchase shares. Assume perfect capital markets.

What is the firm’s earnings per share if it issues debt?

Answer 1

The EPS is computed as shown below:

= (EBIT - Amount of debt x interest rate) / (current number of shares - shares repurchased)

Shares repurchased is computed as follows:

= Amount of debt raised / price per share

= $ 150 million / $ 7.50

= 20 million shares

So, the EPS will be computed as follows:

= ($ 100 million - $ 150 million x 8%) / (50 million - 20 million)

= $ 2.93 Approximately

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