Question

Quisco Systems has 6.6 billion shares outstanding and a share price of $18.41. Quisco is considering developing a new networking product in house at a cost of $498 million.​ Alternatively, Quisco can acquire a firm that already has the technology for $913 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 are incurred this year.and are treated as an R&D expense. Quisco’s tax rate is35%, and the number of shares outstanding is unchanged.
B. Suppose Quisco does not developthe product in house but instead acquire the technology. What effect would the acquisition have on Quisco’s EPS thisyear?
C. Which method of acquiring the technology has a smaller impact on earning? Is this method cheaper?Explain.

Answer 1

A) EPS will decrease by $0.05 to $0.69

B) EPS will decrease by $0.01 to $0.73

C) The impact on EPS is smaller if the company is acquired. This doesn't mean that it is cheaper to do it that way, but since the EPS is very low, any significant increase in costs will result in steep reduction of EPS. The cheapest way would be to issue new stocks to cover the expenses of developing the new technology.

Step-by-step explanation:

6.6 billion shares outstanding and a share price of $18.41, current EPS $0.74, total current earnings = $4,884 million

in house development = $498 million will reduce net earnings by $498 x 65% = $323.7 million or $0.05 per share

EPS = $0.74 - $0.05 = $0.69

if Quisco decides to acquire the company, then total shares will increase by $913,000,000 / $18.41 = 49,592,613 shares

total outstanding shares = 6,600,000,000 + 49,592,613 = 6,649,592,613 shares

EPS = $4,884,000,000 / 6,649,592,613 = $0.73