Quisco Systems has 6.3 billion shares outstanding and a share price of $ $17.47.
ID: 2783729 • Letter: Q
Question
Quisco Systems has 6.3 billion shares outstanding and a share price of $ $17.47. Quisco is considering developing a new networking product in house at a cost of $455 million. Alternatively, Quisco can acquire a firm that already has the technology for $901 million worth (at the current price) of Quisco stock. Suppose that absent the expense of the new technology, Quisco will have EPS of $0.61.
a. Suppose Quisco develops the product in house. What impact would the development cost have on Quisco's EPS? Assume all costs are incurred this year and are treated as an R&D expense, Quisco's tax rate is 35%, and the number of shares outstanding is unchanged.
b. Suppose Quisco does not develop the product in house but instead acquires the technology. What effect would the acquisition have on Quisco's EPS this year? (Note that acquisition expenses do not appear directly on the income statement. Assume the firm was acquired at the start of the year and has no revenues or expenses of its own, so that the only effect on EPS is due to the change in the number of shares outstanding.)
c. Which method of acquiring the technology has a smaller impact on earnings? Is this method cheaper? Explain.
Explanation / Answer
Solution A Current EPS 0.61 Shared outstanding 6.3 Net Income after tax 6.3*0.61 3.843 Tax rate 35% Before Tax profits =3.843/(1-35%) Before Tax profits 5.912308 Less R & D expense 0.455 Before Tax revised profit 5.457308 Tax @ 35% -1.910058 After tax profit 3.54725 Shared Outstanding 6.3 Revised EPS =3.54725/6.3 Revised EPS 0.56 Solution B New company value 901 million Current share price 17.47 No of new shared issued =901/17.47 51.57413 milion Old no of shared 6300 milion Total No of shares 6351.574 milion After tax profit 3.843 Taken from solution A No of shares 6.351574 billion New EPS 0.61 Since the EPS is going very down in soution A, it is suggested to go with solution B to purchase the new technology