Jackson Software, Inc. is an all-equity firm with 2 million shares outstanding,
ID: 1170240 • Letter: J
Question
Jackson Software, Inc. is an all-equity firm with 2 million shares outstanding, $6 million in earnings after taxes, and a market value of $100 million. The firm borrows $25 million at an interest rate of 8% and buys back 500,000 shares with the proceeds. The firm's tax rate is 40%. Management does not want the earnings performance to disappoint shareholders and market analysts. What is the maximum interest rate the firm could pay on its new debt so as not to experience a decrease in earnings per share after the stock repurchase?
Select one:
A. 8.00%
B. 10.00%
C. 11.50%
D. 12.60%
E. None of the above
Explanation / Answer
Calculation of EPS before Repurchase:
Earnings after Taxes = 6000,000 i.e. Earnings before Taxes = 10000,000
No of Shares Outstanding 2000,000
EPS = 3
Revised no. Of common shares outstanding = 1500,000
Required EPS = 3
Required Earnings after Tax = 4500,000
Tax Rate = 40%
Required Earnings before Tax = 7500,000
Earned Income = 10000,000
Maximum Interest that can be Paid = 2500,000
Max Interest in % = 2500,000/25000000*100 = 10.00% i.e. B
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