Assume that Rose Corporation’s (RC) EBIT is not expected to grow in the future a

Question

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 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.

Prior to any borrowing and share repurchase, RC’s EPS is closest to:

(1) $0.60
(2) $1.00
(3) $1.20
(4) $0.50

Explanation / Answer

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 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.

Prior to any borrowing and share repurchase, RC’s EPS is closest to:

(1) $0.60
(2) $1.00
(3) $1.20
(4) $0.50

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