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To: Chuzzlewit who wrote (83849)	12/5/1998 1:52:00 PM
From: Geoff Nunn	Respond to of 176387

Chuz: re You are assuming that better opportunities for using the cash may exist (other than the risk-free rate of return), No I am not! I am merely assuming the risk-free rate is available, and is the firm's opportunity cost (the ding to its earnings) when it releases cash to buy back shares. Thanks for your efforts to find some way for us to resolve this impasse. It seems you may be as frustrated as I! Geoff

To: Chuzzlewit who wrote (83849)	12/6/1998 11:59:00 AM
From: Geoff Nunn	Read Replies (1) \| Respond to of 176387

To Chuz - subj: how do stock buy-backs impact EPS (with full apologies to Voltaire <gg>) When a firm engages in a repurchase of shares, what happens to its EPS? I submit the answer depends on the firm's p/e ratio. If the stock sports a high multiple, a buy-back will cause EPS to fall, and if the stock carries a low multiple then the buy back will raise EPS. Here is a simple arithmetic example. Suppose a firm has $100 MM assets, consisting of $80 MM non-cash assets and $20 MM cash. Let's assume there are 1 MM s/o. The market price/sh. = $100. Let's assume the stock carries a p/e = 50/1. These figures imply that the firm's total earnings are $2 MM. The firm's EPS can be calculated as $2 MM / 1 MM shares = $2. Now suppose the firm spends all its cash reserves on a buy-back, repurchasing 200,000 sh. If we assume the risk-free rate of interest is .05, the firm's interest income will fall by $1 MM. This means the revised EPS will be $1 MM / 0.8 MM sh. = $1.25 per sh. In this example the share buy back causes EPS to decline by 37.5%. A similar example can be constructed to show that a low p/e stock would experience a rise in EPS. A share repurchase is not a free lunch for the firm. When the firm spends cash to repurchase shares, it gives up the interest that cash could otherwise have earned. So a buy back has two effects: (1)fewer shares outstanding, and (2)lower total earnings. What happens to EPS depends on the firm's p/e and how it compares to 1/r, where r is the rate of interest. If p/e > 1/r, the buy back will cause EPS to fall, and if p/e < 1/r, the opposite will be true. If p/e = 1/r, the buy back will leave EPS unaffected. The fact that EPS may decline in a buy back isn't the whole story. If a high p/e stock is receiving a lot of interest income from cash reserves, that acts as a drag on its future earnings growth rate. If the firm throws off the cash, its EPS will grow faster, albeit starting from a new, lower figure. Geoff