Share buybacks are sometimes motivated by the desire to increase earnings per share. Falcon Ltd recorded an operating profit of $2 million in the last financial year. It has 4 million shares on issue and the market price of the shares is $5 each. Falcon announces that it will repurchase 10 per cent of each shareholders shares at $5 per share.

a) Calculate Falcons priceearnings ratio before the buyback. b) An observer comments as follows: Falcons buyback should boost its earnings per share from 50 cents to 55 cents, so with the priceearnings ratio remaining the same, the share price should increase.

i) If the observers argument is correct, what will Falcons share price be after the buyback?

ii) Critically evaluate the observers argument.