Question

Nielson Motors is currently an all-equity financed firm. It expects to generate EBIT of $20 million over the next year. Currently Nielson has 8 million shares outstanding and its stock is trading at $20.00 per share. Nielson is considering changing its capital structure by borrowing $50 million at an interest rate of 8% and using the proceeds to repurchase shares. Assume perfect capital markets. Nielson's EPS if they change their capital structure is closest to _____ $/share.

• A. 2.50
• B. 2.90
• C. 2.00
• D. 2.30

Answer 1

Market price of stock= $ 20 per share

Number of outstanding stock= 8 million

Debt taken= $ 50 million

EBIT= $ 20 million

Rate of interest on Debt= 8%

No. stock to be repurchased= $50 million/ $20 per share= 2.5 million share

No. of stock remaining after stock repurchase= 8-2.5 = 5.5 million

EBT= EBIT-interest= $ 20 m-$ (50*8%)= $ 16 million

Earning per share after stock repurchase= EBT/ Outstanding stock after re-purchase

= $ 16 m / 5.5 m

= $ 2.90 per share