Volga Publishing is considering a proposed increase in its debt ratio,which would also increase the company's interest expense.The plan would involve issuing new bonds and using the proceeds to buy back shares of its common stock.The company's CFO thinks the plan will not change total assets or operating income but that it will increase earnings per share (EPS).Assuming the CFO's estimates are correct,which of the following statements is correct?
A)Since the proposed plan increases Volga's financial risk, the company's share price still might fall even if EPS increases.
B)If the plan reduces the WACC, the share price is also likely to decline.
C)Since the plan is expected to increase EPS, this implies that net income is also expected to increase.
D)If the plan does increase the EPS, the share price will automatically increase at the same rate.

Question

Quizplus · Accepted Answer

Increasing the debt ratio increases the financial risk of the company, which might not be viewed positively by shareholders. Therefore, even if EPS increases, the share price might still fall.

Answer: C 
 If the plan increases EPS, it means that net income is likely to increase, as EPS is calculated by dividing net income by the number of outstanding shares.

Therefore, the correct choices are A and C.

Option B is incorrect, as if the plan reduces the WACC, it would reduce the cost of capital for the company, and the share price is likely to increase, not decline. Option D is incorrect, as the share price might not increase at the same rate as EPS, as shareholders might not view an increase in financial risk positively.

Volga Publishing Is Considering a Proposed Increase in Its Debt