Unit 1 Ethics Case: Purchase of Treasury Stock

Rayovac has several debt covenants related to its bonds payable. One covenant

requires Rayovac to keep earnings per share above $5.00. A month before yearend,

Jim Jones, the controller, is working on the 20xx annual report. Based on

estimated earnings and the weighted average number of shares of stock

outstanding, the earnings per share is currently $4.25. Jim believes that the only

way the company can increase earnings per share to reach $5.00 in one month is to

borrow money and purchase treasury stock. If the company borrows money for this

purpose, however, it will find it difficult to negotiate an operating loan during the first

quarter of the next year. (It is expected that the company will need to borrow funds

to meet operational needs for the first quarter of next year.) Jim isn't sure about

purchasing the treasury stock this year because, although it will solve the problem of

debt covenant this month, it will create cash flow problems in the following year.

Required:

Prepare response following the four step ethics framework. In addition to

following the framework be sure to also answer the following questions within your

response:

1. Does the purchase of treasury stock have the required outcome on earnings

per share? Explain.

2. If the company violates the debt covenant, what might the creditors do?

3. Would your recommendation to Jim change if Rayovac had excess cash, and

purchasing the treasury stock was one of several alternatives for spending the

excess cash?

4. Would your recommendation to Jim change if the current stock price of

Rayovac stock was unusually high? Why?

5. Would your recommendation to Jim change if the current stock price of

Rayovac stock was at a five-year low? Why?