Keystone Enterprises (a fictional company) just announced record 20X1 EPS of $5.00, up $0.25 from last year. This is the 10th consecutive year that the company has increased its EPS, an enviable record. Unfortunately, management fears that this string of EPS increases is about to be broken. Keystone is forecasting net income for 20X2 and 20X3 at $10 million each year, the same level earned in 20X1. The company has 2,000,000 shares of common stock outstanding, no preferred stock, and no convertible debt.

Required:

1. How many common shares does Keystone need to buy back at the beginning of 20X2 and 20X3 to maintain EPS growth of $0.25 per share each year? (Note: Keystone will use excess cash from operations to pay for the stock.)

2. Explain why your answer to requirement 1 would change if the buybacks were to occur in the middle of each year.

3. Why do you think Keystone’s management would be concerned about maintaining the company’s record of EPS growth?