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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 $317.

Variable cost per unit $198

Units sold 315

Fixed costs $9,229

Interest expense 19,455

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 6.6 percent?

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

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Expert Solution

Answer:

What will be the resulting percentage change in earnings per share of Rat Race Home Security, Inc. if they expect operating profit to change 6.6 percent?

We should calculate the degree of financial leverage first:

Alternatively,

              

      

Degree of financial leverage = EBIT ÷ EBT

                                              =$28,186 ÷ $8,731

                                             = 3.23 Times

What will be the resulting percentage change in earnings per share of Rat Race Home Security, Inc. if they expect operating profit to change 6.6 percent?

Percentage change in Operating profit (EBIT) =6.6%

Degree of Financial Leverage = 3.23 times

i.e. 3.23 = percentage change in EPS ÷ Percentage change in EBIT

Percentage change in earnings per share =Degree of financial leverage * Percentage change in  

                                                                                                                     Operating profit(EBIT)

                                                                                          =3.23*6.6

                                                                                         =21.318

Notes:

Average selling price per unit = $317.

Units sold = 315 units

Total sales = 315 units*$317

                   = $ 99,855

Variable cost per unit = $198

Total Variable cost= 315 units*$198

                                    =$62,370

Fixed costs = $9,229

Interest expense =$ 19,455

EBIT = Sales-(Variable cost+ Fixed Cost)

        = $ 99,855 - ($62,370+$9,299)

        = $99,855 – $71,669

        =$28,186

EBT = EBIT - Interest expense

        =$28,186 - $19,455

        =$8,731

jeff jeffy answered 6 months ago
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