CONTEMP. FINANCIAL MGT.-W/MINDTAP V3
CONTEMP. FINANCIAL MGT.-W/MINDTAP V3
14th Edition
ISBN: 9780357292839
Author: MOYER
Publisher: CENGAGE L
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Chapter 14, Problem 20P

a.

Summary Introduction

To compute: Indifference points of EBIT and EPS.

a.

Expert Solution
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Explanation of Solution

Given information:

Tax rate: 40%

Average EBIT level: $6 million (per year)

Calculating EBIT-EPS indifference point:

Indifference can be seen, when debt financing EPS is considered equals to equity financing EPS,

Now,

                      EPS Plan 1 = EPS Plan 2EBIT Interest1TaxOutstanding shares=EBIT Interest1TaxOutstanding shares             EBIT01.42 = EBIT1.21.41                                  EBIT = $2.4million

Therefore, the indifference point will be seen when EBIT become $2.4million

b.

Summary Introduction

To compute: Earning per share for financial plan 1 and plan 2.

b.

Expert Solution
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Explanation of Solution

Calculating EPS for both financial plans:

 Plan 1 ($)Plan 2 ($)
EBIT6.06.0
Interest0.01.2
Earning before tax6.04.8
Tax@40%2.41.92
Earnings after tax3.62.88
Outstanding shares2.01.0
EPS1.802.88

Table (1)

Therefore, the earning per share for Plan 1 will be $1.80 and Plan 2 will be $2.88

c.

Summary Introduction

To determine: Factors for financial planning.

c.

Expert Solution
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Explanation of Solution

The factors for financial planning are as mentioned below:

  • Capital structure, which is effectively followed by the parent company.
  • Impact of financial plan on the financial status as well as stocks prices of the company.
  • Probability distribution as per the expectation identified through EBIT.

d.

Summary Introduction

To determine: Suitable financial plan.

d.

Expert Solution
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Explanation of Solution

The plan 2 is must be recommended, because EPS (debt financing) is higher the EPS (equity financing).

e.

Summary Introduction

To compute: Earning per share when sales decreases by 5%.

e.

Expert Solution
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Explanation of Solution

Time Interest Earned Ratio = EBITInterest                                         = 6.01.2                                         = 5 Times

Therefore, the time interest earned ratio will be 5 times.

f.

Summary Introduction

To compute: EBIT dropping level.

f.

Expert Solution
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Explanation of Solution

Level of EBIT = Interest× Time interest earned ratio                        = 1.2(3.5)                        = $4.2 million

Therefore, the EBIT is supposed be drop by $1.8 (after deducting current EBIT from lower level). Along with that, it is required for the company to compliance with the agreement of loan.

g.

Summary Introduction

To compute: Probability of negative EPS.

g.

Expert Solution
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Explanation of Solution

Calculating earnings per share negative probability:

Z score = Loss levelExpected EBITStandard deviation            = $0$600,000$300,000             = 2.0

From Table V, the probability of a value greater than 2.0 standard deviations to the left of the mean is 2.28%, i.e. small.

Therefore, the probability of negative earning per share will be 2.28%.

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