A firm issues 100,000 shares of common stock with a total market value of $5,000,000 and an equal amount of debt.The firm is expected to generate $1.5 million in operating income and pay $250,000 in interest.If the firm does not pay tax,what will happen to EPS if the firm repurchases $2,500,000 of shares and substitutes an equal amount of additional debt?
A) EPS decreases by 33.3% to $10.00.
B) EPS decreases by 6.7% to $11.67.
C) EPS increases by 20% to $15.00.
D) EPS increases by 80% to $22.50.

Question

Quizplus · Accepted Answer

The firm repurchases half of its shares, reducing the number of shares to 50,000. The operating income remains $1.5 million, but interest expense increases to $500,000. The new EPS is ($1,500,000 - $500,000) / 50,000 = $20.00, which is an 80% increase from the original EPS of $11.25.

A Firm Issues 100,000 Shares of Common Stock with a Total