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Use the following information about Rat Race Home Security, Inc. to answer the questions: Average selling...

Use the following information about Rat Race Home Security, Inc. to answer the questions:

Average selling price per unit $334.

Variable cost per unit $187

Units sold 317

Fixed costs $6,748

Interest expense 16,203

Based on the data above, what will be the resulting percentage change in earnings per share of Rat Race Home Security, Inc. if they expect operating profit to change 8.3 percent?

(You should calculate the degree of financial leverage first).

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Expert Solution

Contribution per unit = Average selling price per unit - Variable cost per unit = $334 - $187

Contribution per unit = $147

Total Contribution = Contribution per unit*No of units sold = $147*317

Total Contribution = $46,599

EBIT = Total Contribution - Fixed costs = $46,599 - $6,748

EBIT = $39,851

- Degree of Financial Leverage = EBIT/(EBIT - Interest Expenses)

Degree of Financial Leverage = $39,851/($39,851- $16,203)

Degree of Financial Leverage = 1.6852 times

- Change in operating Profit(or EBIT) = 8.3%

As Degree of Financial Leverage remains same and with change of EBIT, earnings per share(EPS) will also change.

Degree of Financial Leverage = % change in EPS/% change in EBIT

1.6852 = % change in EPS/8.3%

% change in EPS = 13.99%

So,the resulting percentage change in earnings per share of Rat Race Home Security, Inc is 13.99%

If you need any clarification, you can ask in comments.    

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jeff jeffy answered 2 years ago
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