Quisco Systems has 6.3 billion shares outstanding and a share price of $18.59. Q
ID: 2814957 • Letter: Q
Question
Quisco Systems has 6.3 billion shares outstanding and a share price of $18.59. Quisco is considering developing a new networking product in house at a cost of $461 million. Alternatively, Quisco can acquire a firm that already has the technology for $967 million worth (at the current price) of Quisco stock. Suppose that absent the expense of the new technology, Quisco will have EPS of $0.74 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? ExplainExplanation / Answer
Step 1: Calculation of current earnings available to equity shareholders
EPS = current earnings available to equity shareholders / Shares outstanding
.74 = current earnings available to equity shareholders / 6.3 billion
current earnings available to equity shareholder = .74*6.3 billion
current earnings available to equity shareholder = 4.662 billion
a) Calculation of EPS when develops the product in house
Revised earnings available to equity shareholder = 4.662 billion - (.461 billion*.65)
= 4.662 billion-.29965 billion
= 4.36235 billion
Revised EPS = 4.36235 billion / 6.3 billion
= .69
b) Calculation of EPS when does not develops the product in house
current earnings available to equity shareholder = 4.662 billion
New shares issued = .967 billion/18.59
= .05202 billion
New shares Outstanding = 6.3 billion+ .05202 billion
= 6.3520 billion
Revised EPS = 4.662 billion / 6.3520 billion
= .73
c) Impact on EPS
The option not to develop the product in house but instead acquire the technology has smaller impact on EPS.But it cost more than the cost to develop the product in house. But it does not affect the share price greatly since it has smaller impact on EPS. Developing the product in house is cheaper,but it will affect the share price greatly since it has great impact on EPS.