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Assume that Rose Corporation's (RC) EBIT is not expected to grow in the future and that all earnings are paid out as dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of $12.00.
-Following the borrowing of $12 million and the subsequent share repurchase,the expected earnings per share for RC is closest to:

Question

Quizplus · Accepted Answer

A) EPS = (EBIT) / Shares outstanding = ($6M) / 5M shares = $1.20 EPS (unlevered)
$12 million / $12 per share = 1 million shares repurchased, so 5M shares initially - 1M shares repurchased = 4M total shares outstanding.
EPS = (EBIT - Interest) / Shares outstanding = ($6M - .06 × $12) / 4M shares = $1.32 EPS

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