A buyback that raises EPS while reducing profit
Series XV case study · set 1, case 3 of 5 · 4 questions · 1 mark each
Question 1 of 4Case practice
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Before a hypothetical buyback, a company earns ₹100 crore annually and has 10 crore ordinary shares. It buys back and cancels 1 crore shares at ₹150 each. The cash spent previously earned interest, so assume annual net profit falls by ₹6 crore after the buyback, with no other change. The market price used for the post-buyback valuation comparison remains ₹150. Ignore taxes and transaction costs. All figures are pro forma for a full year on the new share count. The analyst must distinguish an increase in EPS from an increase in total earnings or an automatic creation of shareholder value.
All people, firms, prices and contract terms are fictional.
Ignore taxes and transaction costs unless the case explicitly includes them.
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The case and its answers
Every question of this case, with its answer and why each other option is wrong.
Before a hypothetical buyback, a company earns ₹100 crore annually and has 10 crore ordinary shares. It buys back and cancels 1 crore shares at ₹150 each. The cash spent previously earned interest, so assume annual net profit falls by ₹6 crore after the buyback, with no other change. The market price used for the post-buyback valuation comparison remains ₹150. Ignore taxes and transaction costs. All figures are pro forma for a full year on the new share count. The analyst must distinguish an increase in EPS from an increase in total earnings or an automatic creation of shareholder value.
All people, firms, prices and contract terms are fictional.
Ignore taxes and transaction costs unless the case explicitly includes them.
Q1How many ordinary shares remain after cancellation?
Option A. 10 crore shares
Why it is wrong: This ignores cancellation of the repurchased shares.
Option B. 9 crore shares — Correct answer
Option C. 11 crore shares
Why it is wrong: This treats a buyback as a new issue.
Option D. 1 crore shares
Why it is wrong: This is the number bought back, not the number remaining.
Answer: B. 10 crore − 1 crore = 9 crore shares. Remember: A cancelled buyback reduces the outstanding share count.
Hint, shown before you answer in practice mode: Subtract cancelled shares from the original count.
XV-S1-C03-Q1easynumerical
Q2What is pro forma EPS after the buyback, rounded to two decimals?
Option A. ₹9.40
Why it is wrong: This uses the original 10 crore shares.
Option B. ₹10.00
Why it is wrong: This is EPS before the transaction.
Option C. ₹11.11
Why it is wrong: This ignores the lost ₹6 crore profit.
Option D. ₹10.44 — Correct answer
Answer: D. Profit becomes ₹100 − ₹6 = ₹94 crore. EPS = ₹94 crore/9 crore shares = ₹10.44. Remember: EPS effects depend on both earnings changes and share cancellation.
Hint, shown before you answer in practice mode: Adjust both profit and share count.
XV-S1-C03-Q2mediumnumerical
Q3At the unchanged ₹150 price, what is the post-buyback P/E multiple?
Option A. 16.00 times
Why it is wrong: This is inconsistent with ₹94 crore earnings and 9 crore shares.
Option B. 15.00 times
Why it is wrong: This uses pre-buyback EPS of ₹10.
Option C. 14.36 times — Correct answer
Option D. 13.50 times
Why it is wrong: This uses EPS without the lost interest income.
Answer: C. ₹150 ÷ (₹94/9) = 14.36 times, rounded. Remember: Keep the valuation price and earnings measure on the same share basis.
Hint, shown before you answer in practice mode: Use the unrounded pro forma EPS in the denominator.
XV-S1-C03-Q3mediumnumerical
Q4Which statement is justified by these figures?
Option A. The buyback is costless because shares are cancelled.
Why it is wrong: It uses cash and removes interest income.
Option B. EPS rises even though total profit falls. This alone does not prove value creation. — Correct answer
Option C. Total profit rises because EPS rises.
Why it is wrong: Total profit falls from ₹100 crore to ₹94 crore.
Option D. Every remaining shareholder receives a guaranteed price gain.
Why it is wrong: The case holds the market price unchanged and provides no guarantee.
Answer: B. The denominator falls proportionally more than profit, lifting EPS. Whether the transaction creates value requires analysis of price paid, alternatives and risks. Remember: Per-share accretion and economic value creation are not identical.
Hint, shown before you answer in practice mode: Compare aggregate earnings with earnings per remaining share.
XV-S1-C03-Q4mediumapplication
Operating leverage in a single-product company
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