A firm's CFO is considering increasing the target debt ratio, which would also increase the company's interest expense. New bonds would be issued and the proceeds would be used to buy back shares of common stock. Neither total assets nor operating income would change, but expected earnings per share (EPS) would increase. Assuming the CFO's estimates are correct, which of the following statements is CORRECT?
A. Since the proposed plan increases the firm's financial risk, the stock price might fall even if EPS increases.
B. If the plan reduces the WACC, the stock price is likely to decline.
C. Since the plan is expected to increase EPS, this implies that net income is also expected to increase.
D. If the plan does increase the EPS, the stock price will automatically increase at the same rate.
E. Under the plan there will be more bonds outstanding, and that will increase their liquidity and thus lower the interest rate on the currently outstanding bonds.
Answer: A
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