22. Wealth and Health Company is financed entirely by common stock which is pric

Question

22. Wealth and Health Company is financed entirely by common stock which is priced to offer a 15% expected return. The common stock price is $40/share. The earnings per share is expected to be S6. If the company repurchases 25% of the common stock and substitutes an equal value of debt yielding 6%, what is the expected value of earnings per share after refinancing? (Ignore taxes.) A) $6.00 B) $7.52 C) $7.20 D) None of the above Answer: C Type Difficult Page: 452 Response: I = (10)(0.06) = 0.60; new EPS = (6-0.60)0.75 = $7.20/share

Explanation / Answer

Answer is Option (c )   $7.20 Market Price of a Common Stock =$40 Earnings per Share =$6 Value of Common stock required to repurchase =25% Amount paid for Repurchaase =$40*25% =$10 Amount of debt equal to amount paid for repurchase =$10 Interest to be paid on debt =$10*6% =$0.60 Earnings per share after repurchase =[ EPS (original ) - Interest on debt ] /Number of Common stock =($6.00-$0.60) /(1.00-0.25) =$5.40/0.75 =$7.20 7.2

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