Daylight Solutions is considering a recapitalization that would increase its deb

Question

Daylight Solutions is considering a recapitalization that would increase its debt ratio and increase its interest expense. The company would issue new bonds and use the proceeds to buy back shares of its common stock. The company's CFO thinks the plan will not change total assets or operating income, but that it will increase earnings per share (EPS). Assuming the CFO's estimates are correct, which of the following statements is CORRECT?

a. If the plan reduces the WACC, the stock price is also likely to decline.
b. Since the plan is expected to increase EPS, this implies that net income is also expected to increase.
c. If the plan does increase the EPS, the stock price will automatically increase at the same rate.
d. Under the plan there will be more bonds outstanding, and that will increase their liquidity and thus lower the interest rate on the currently outstanding bonds.
e. Since the proposed plan increases Daylight's financial risk, the company's stock price still might fall even if EPS increases.

Explanation / Answer

First Statement is incorrect because if WACC declines stock price will increase

Second Statement is incorrect because with the increase in EPS it is not necessary that net income will also increase.

Third statement is incorrect because price of the share doesnot only depend upon EPS but it also depends upon Price Earning Ratio

Fourth Statement is incorrect because with the increase in bonds outstanding liquidity of the of the firm will not increase but it will decline because the interest payment will increase

Fifth Statement is correct because share price depends not only on EPS but also on Price Earning Ratio

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