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.


Following the borrowing of $12million and subsequent share repurchase, the value of a share of RC is closest to:

(1) $14.00
(2) $13.20
(3) $12.00
(4) $10.80

Explanation / Answer

Ans: 1.32 (this is assuming there are no taxes) EBIT = 6,000,000 Less Interest on borrowing @6% 720,000 Earning before Taxes 5,280,000 After the repurchase RC would have 4 million shares outstanding, hence the new EPS (before taxes) should be 5,280,000/4,000,000 = 1.32

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.