Question

A company is financed entirely with equity. It has 100,000 shares outstanding. The company proposes to issue $250,000 of debt at an interest rate of 10% per annum and repurchase 25,000 shares at market. The company pays no taxes (thus, the debt has no tax shield). Net income before the issuance of debt is expected to be $125,000.

(a) What is the price per share before the repurchase?

(b) What is the EPS before the repurchase?

(c) What is the P/E ratio before the repurchase?

(d) What is the price per share after the repurchase?

(e) What is the EPS after the repurchase?

(f) What is the P/E ratio after the repurchase?

Answer 1

Before repurchase:

Number of shares outstanding = 100,000

After repurchase:

Number of shares outstanding = 100,000 - 25,000 = 75,000
Value of Debt = $250,000

Interest = 10% * $250,000
Interest = $25,000

Answer a.

Price per share = Value of Debt / Number of shares repurchased
Price per share = $250,000 / 25,000
Price per share = $10

Answer b.

EPS = Net Income / Number of shares outstanding
EPS = $125,000 / 100,000
EPS = $1.25

Answer c.

P/E Ratio = Price per share / EPS
P/E Ratio = $10 / $1.25
P/E Ratio = 8

Answer d.

Price per share = Value of Debt / Number of shares repurchased
Price per share = $250,000 / 25,000
Price per share = $10

Answer e.

EPS = (EBIT - Interest) / Number of shares outstanding
EPS = ($125,000 - $25,000) / 75,000
EPS = $1.33

Answer f.

P/E Ratio = Price per share / EPS
P/E Ratio = $10 / $1.33
P/E Ratio = 7.52