Box 14.5 in this chapter demonstrated how increases in leverage can increase earnings-per-share growth. Suppose the leverage
Question:
Box 14.5 in this chapter demonstrated how increases in leverage can increase earnings-per-share growth. Suppose the leverage change was due to a stock repurchase where the repurchase was financed by the borrowing. Answer the following questions regarding the effect of the stock repurchase.
a. Why does the stock repurchase have no effect on the per-share value of the equity?
b. Why does forecasted earnings for Year 1 decrease from $10.00 million to $7.50 million?
c. Why does forecasted EPS for Year I increase while forecasted earnings decrease?
d. The required return prior to the stock repurchase was 10 percent. What is the required return for the equity after the stock repurchase?
e. What is the expected residual earnings (on equity) for Year 1 after the repurchase?
f. Forecast the value of the equity at the end of Y ear 1 for both the case with no leverage and the case with leverage.
g. Forecast the PIE at the end of Year 1 for both the case with no leverage and the case with leverage. Why are they different?
Step by Step Answer:
Financial Statement Analysis and Security Valuation
ISBN: 978-0078025310
5th edition
Authors: Stephen Penman