I have read that if the after tax yield is greater than the earnings yield, eps would fall as a result of repurchase of stock and vice-versa. I have understood the calculations in the solved examples but cannot understand the intution behind the statement.
I want to know as to why eps falls if after tax yield>earnings yield?
Can anyone please explain?
The intuition is that using a cheaper source of capital you are bette off.
Let say you have a credit card debt with an interest of 20% and you can go to the bank and get a loan to payoff your credit card at 10%. You are better off.
Back to your question. If the after tax rate is lower than the yield on your stock, it makes sense to borrow money and buy back the stock. You give away less money (higher net income) and you split it among less stock.
Mathematically, the denominator (Weighted Avg cost equity blah blah) would decrease as a result of the share buy back, increasing EPS, if numerator is ceteris paribus.
5/100 v 5/50
Share repurchase decreases denominator, increases quotient.
I thought when you repurchase shares, they become treasury stocks, so how come your demoninator is increasing instead of the opposite?