Question

MC Qu. 40 A share repurchase will:...

A share repurchase will:

Multiple Choice

• increase both earnings per share and the PE ratio.

• increase the earnings per share but not affect the PE ratio.

• increase the earnings per share and decrease the PE ratio.

• not affect either the earnings per share nor the PE ratio.

• not affect the earnings per share but will decrease the PE ratio.

Answer 1

The correct answer is " increase the earnings per share and decrease the PE ratio. "

The reason for the same is explained below:

Formula to calculate earnins per share (EPS) = Earnings/Total number of shares outstanding

Formula to calculate PE ratio = Price / EPS

Now let us understand the situation through an example.

Let's assume Total Earnings of a firm is Rs. 1,00,000 and total number of shares outstanding are 5000.

So current EPS = 100000 / 5000 = Rs. 20

Say the Company repurchased/bought back 1000 shares. This would reduce the total number of shares outstanding to 4000.

So the revised EPS would be 100000 / 4000 = Rs. 25

Hence, we can say EPS has increased after repurchase.

Now lets assume price of the company's share is Rs.500.

So PE ratio before repurchase is 500 / 20 = 25

Now PE ratio after repurchase is 500 / 25 = 20

So PE ratio has decreased after repurchase.