Indifference points of EBIT and EPS.

Question

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Answer 1

Question

Chapter 14, Problem 20P

a.

Summary Introduction

To compute: Indifference points of EBIT and EPS.

a.

Expert Solution

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− Interest1−TaxOutstanding shares= EBIT− Interest1−TaxOutstanding shares EBIT−01−.42 = EBIT−1.21−.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

Explanation of Solution

Calculating EPS for both financial plans:

	Plan 1 ($)	Plan 2 ($)
EBIT	6.0	6.0
Interest	0.0	1.2
Earning before tax	6.0	4.8
Tax@40%	2.4	1.92
Earnings after tax	3.6	2.88
Outstanding shares	2.0	1.0
EPS	1.80	2.88

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

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

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

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

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

Explanation of Solution

Calculating earnings per share negative probability:

Z score = Loss level−Expected 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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Answer 2

Question

Chapter 14, Problem 20P

a.

Summary Introduction

To compute: Indifference points of EBIT and EPS.

a.

Expert Solution

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− Interest1−TaxOutstanding shares= EBIT− Interest1−TaxOutstanding shares EBIT−01−.42 = EBIT−1.21−.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

Explanation of Solution

Calculating EPS for both financial plans:

	Plan 1 ($)	Plan 2 ($)
EBIT	6.0	6.0
Interest	0.0	1.2
Earning before tax	6.0	4.8
Tax@40%	2.4	1.92
Earnings after tax	3.6	2.88
Outstanding shares	2.0	1.0
EPS	1.80	2.88

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

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

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

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

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

Explanation of Solution

Calculating earnings per share negative probability:

Z score = Loss level−Expected 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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Answer 3

Question

Chapter 14, Problem 20P

a.

Summary Introduction

To compute: Indifference points of EBIT and EPS.

a.

Expert Solution

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− Interest1−TaxOutstanding shares= EBIT− Interest1−TaxOutstanding shares EBIT−01−.42 = EBIT−1.21−.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

Explanation of Solution

Calculating EPS for both financial plans:

	Plan 1 ($)	Plan 2 ($)
EBIT	6.0	6.0
Interest	0.0	1.2
Earning before tax	6.0	4.8
Tax@40%	2.4	1.92
Earnings after tax	3.6	2.88
Outstanding shares	2.0	1.0
EPS	1.80	2.88

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

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

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

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

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

Explanation of Solution

Calculating earnings per share negative probability:

Z score = Loss level−Expected 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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Answer 4

Question

Chapter 14, Problem 20P

a.

Summary Introduction

To compute: Indifference points of EBIT and EPS.

a.

Expert Solution

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− Interest1−TaxOutstanding shares= EBIT− Interest1−TaxOutstanding shares EBIT−01−.42 = EBIT−1.21−.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

Explanation of Solution

Calculating EPS for both financial plans:

	Plan 1 ($)	Plan 2 ($)
EBIT	6.0	6.0
Interest	0.0	1.2
Earning before tax	6.0	4.8
Tax@40%	2.4	1.92
Earnings after tax	3.6	2.88
Outstanding shares	2.0	1.0
EPS	1.80	2.88

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

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

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

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

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

Explanation of Solution

Calculating earnings per share negative probability:

Z score = Loss level−Expected 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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Answer 5

Chapter 14, Problem 20P

a.

Summary Introduction

To compute: Indifference points of EBIT and EPS.

a.

Expert Solution

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− Interest1−TaxOutstanding shares= EBIT− Interest1−TaxOutstanding shares EBIT−01−.42 = EBIT−1.21−.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

Explanation of Solution

Calculating EPS for both financial plans:

	Plan 1 ($)	Plan 2 ($)
EBIT	6.0	6.0
Interest	0.0	1.2
Earning before tax	6.0	4.8
Tax@40%	2.4	1.92
Earnings after tax	3.6	2.88
Outstanding shares	2.0	1.0
EPS	1.80	2.88

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

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

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

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

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

Explanation of Solution

Calculating earnings per share negative probability:

Z score = Loss level−Expected 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%.

Answer 6

Chapter 14, Problem 20P

a.

Summary Introduction

To compute: Indifference points of EBIT and EPS.

a.

Expert Solution

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− Interest1−TaxOutstanding shares= EBIT− Interest1−TaxOutstanding shares EBIT−01−.42 = EBIT−1.21−.41 EBIT = $2.4million

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

Answer 7

Chapter 14, Problem 20P

a.

Summary Introduction

To compute: Indifference points of EBIT and EPS.

Answer 8

a.

Expert Solution

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− Interest1−TaxOutstanding shares= EBIT− Interest1−TaxOutstanding shares EBIT−01−.42 = EBIT−1.21−.41 EBIT = $2.4million

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

Answer 9

a.

Expert Solution

Answer 10

a.

Expert Solution

Answer 11

Expert Solution

Answer 12

b.

Summary Introduction

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

b.

Expert Solution

Explanation of Solution

Calculating EPS for both financial plans:

	Plan 1 ($)	Plan 2 ($)
EBIT	6.0	6.0
Interest	0.0	1.2
Earning before tax	6.0	4.8
Tax@40%	2.4	1.92
Earnings after tax	3.6	2.88
Outstanding shares	2.0	1.0
EPS	1.80	2.88

Table (1)

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

Answer 13

b.

Summary Introduction

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

Answer 14

b.

Expert Solution

Explanation of Solution

Calculating EPS for both financial plans:

	Plan 1 ($)	Plan 2 ($)
EBIT	6.0	6.0
Interest	0.0	1.2
Earning before tax	6.0	4.8
Tax@40%	2.4	1.92
Earnings after tax	3.6	2.88
Outstanding shares	2.0	1.0
EPS	1.80	2.88

Table (1)

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

Answer 15

b.

Expert Solution

Answer 16

b.

Expert Solution

Answer 17

Expert Solution

Answer 18

c.

Summary Introduction

To determine: Factors for financial planning.

c.

Expert Solution

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.

Answer 19

c.

Summary Introduction

To determine: Factors for financial planning.

Answer 20

c.

Expert Solution

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.

Answer 21

c.

Expert Solution

Answer 22

c.

Expert Solution

Answer 23

Expert Solution

Answer 24

d.

Summary Introduction

To determine: Suitable financial plan.

d.

Expert Solution

Explanation of Solution

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

Answer 25

d.

Summary Introduction

To determine: Suitable financial plan.

Answer 26

d.

Expert Solution

Explanation of Solution

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

Answer 27

d.

Expert Solution

Answer 28

d.

Expert Solution

Answer 29

Expert Solution

Answer 30

e.

Summary Introduction

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

e.

Expert Solution

Explanation of Solution

Time Interest Earned Ratio = EBITInterest = 6.01.2 = 5 Times

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

Answer 31

e.

Summary Introduction

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

Answer 32

e.

Expert Solution

Explanation of Solution

Time Interest Earned Ratio = EBITInterest = 6.01.2 = 5 Times

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

Answer 33

e.

Expert Solution

Answer 34

e.

Expert Solution

Answer 35

Expert Solution

Answer 36

f.

Summary Introduction

To compute: EBIT dropping level.

f.

Expert Solution

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.

Answer 37

f.

Summary Introduction

To compute: EBIT dropping level.

Answer 38

f.

Expert Solution

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.

Answer 39

f.

Expert Solution

Answer 40

f.

Expert Solution

Answer 41

Expert Solution

Answer 42

g.

Summary Introduction

To compute: Probability of negative EPS.

g.

Expert Solution

Explanation of Solution

Calculating earnings per share negative probability:

Z score = Loss level−Expected 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%.

Answer 43

g.

Summary Introduction

To compute: Probability of negative EPS.

Answer 44

g.

Expert Solution

Explanation of Solution

Calculating earnings per share negative probability:

Z score = Loss level−Expected 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%.

Answer 45

g.

Expert Solution

Answer 46

g.

Expert Solution

Answer 47

Expert Solution

Answer 48

Ch. 14.A - Prob. 1QTD Ch. 14.A - Prob. 2QTD Ch. 14.A - Prob. 3QTD Ch. 14.A - Prob. 2P Ch. 14.A - Prob. 3P Ch. 14.A - Prob. 4P Ch. 14.A - Prob. 5P Ch. 14.A - Prob. 6P Ch. 14.A - Prob. 7P Ch. 14.A - Prob. 8P

Indifference points of EBIT and EPS.

Videos

To compute: Indifference points of EBIT and EPS.

Explanation of Solution

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

Explanation of Solution

To determine: Factors for financial planning.

Explanation of Solution

To determine: Suitable financial plan.

Explanation of Solution

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

Explanation of Solution

To compute: EBIT dropping level.

Explanation of Solution

To compute: Probability of negative EPS.

Explanation of Solution

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Chapter 14 Solutions