A firm has a market value equal to its book value. Currently,the firm has excess cash of $1,000 and other assets of $6,000. Equity is worth $18,000. The firm has 700 shares of stock outstanding and net income of $1,200. What will the new earnings per share be if the firm uses its excess cash to complete a stock repurchase?

Question

Quizplus · Accepted Answer

The current book value of the firm is $25,000 [($18,000 equity) + ($6,000 other assets) + ($1,000 excess cash)]. If the firm uses the $1,000 excess cash to repurchase shares, the equity will decrease to $17,000, and the number of outstanding shares will decrease to 666.67 shares [700 shares - (1,000/18)].

The new earnings per share will be:
New EPS = (Net Income - Dividends) / New Number of Shares Outstanding
New EPS = ($1,200 - 0) / 666.67 = $1.80
Therefore, the new earnings per share after the stock repurchase will be $1.80, which is option C.

A Firm Has a Market Value Equal to Its Book