A company's capital structure consists of common stock only, which amounts to $14 million. However, this year, the company plans to issue $7 million of debt, and use the proceeds to repurchase $7 million of its existing equity. The stock repurchase should not change the size of the company. As a result, any change in the firm's earnings per share (EPS) must be a result of the change in its:
A)level of operations.
B)beta coefficient.
C)EPS coefficient of variation.
D)capital structure.
E)EPS standard deviation.

Question

Quizplus · Accepted Answer

The issuance of debt to repurchase equity will increase the company's debt component of its capital structure while decreasing the equity component, resulting in a change in the company's overall capital structure. This change in the capital structure will affect the company's earnings per share (EPS) by altering its interest expense and its tax shield, resulting in a change in the firm's earnings available to common shareholders. Therefore, the change in EPS is a result of the change in the company's capital structure.

A Company's Capital Structure Consists of Common Stock Only, Which