Question

If a company's after-tax borrowing rate is greater than the company's earning yield when the company repurchases stock with borrowed money, going forward, the earnings per share is most likely to: A. increase. B. decrease. C. remain unchanged.

Answer 1

Answer:

b) Decrease

Explanation:

When a company use borrowed money to repurchase shares, the borrowed money is at a cost, therefore the earnings per share will only increase if the company's earning yield(earnings per share/price per share) is greater than the after-tax cost borrowing rate.

However in the case that the after-tax cost borrowing rate is equal to the company's earning yield, the earnings per share will remain the same, and if the after-tax cost borrowing rate exceeds the company's earning yield, the earnings per share would decrease.