Question

Mr. Gold is in the widget business. He currently sells 1.3 million widgets a year at $7 each. His variable cost to produce the widgets is $5 per unit, and he has $1,640,000 in fixed costs. His sales-to-assets ratio is seven times, and 40 percent of his assets are financed with 9 percent debt, with the balance financed by common stock at $10 par value per share. The tax rate is 35 percent.
  
His brother-in-law, Mr. Silverman, says he is doing it all wrong. By reducing his price to $6.00 a widget, he could increase his volume of units sold by 60 percent. Fixed costs would remain constant, and variable costs would remain $5 per unit. His sales-to-assets ratio would be 10.0 times. Furthermore, he could increase his debt-to-assets ratio to 50 percent, with the balance in common stock. It is assumed that the interest rate would go up by 1 percent and the price of stock would remain constant.
A. Compute earnings per share under the gold plan

B. Compute earnings per share under the silverman plan

Answer 1

a)	Gold Plan
	Sales (1300000 * 7)	9100000
	Less: Fixed Cost	1640000
	Less: Variable Cost	6500000
	EBIT	960000
	Less: Interest(Note 1)	46800
	EBT	913200
	Less: Taxes @35%	319620
	EAT	593580
	No of Shares(Note 2)	78000
	EPS	7.61
	Assets = Sales / Asset Turnover
	=9100000/7
	=1300000
	Debt = 40% of Asset
	=1300000*40%
	=520000
Note 1	Interest = 9% of 520000
	=520000*9%
	=46800
Note 2	Stock = 60% of 1300000
	=780000	780000
	No. of Stock = 780000/10
	=78000	Shares
b)	Silverman Plan
	Sales (1300000*1.6*6)	12480000
	Less: Fixed Cost	1640000
	Less: Variable Cost	10400000
	EBIT	440000
	Less: Interest(Note 1)	62400
	EBT	377600
	Less: Taxes @35%	132160
	EAT	245440
	No of Shares(Note 2)	62400
	EPS	3.93
	Assets = Sales / Asset Turnover
	=12480000/10
	=1248000
	Debt = 50% of Asset
	=1248000*50%
	=624000
Note 1	Interest = 10% of 624000
	=62400
Note 2	Stock = 50% of 1248000
	=624000
	No. of Stock = 624000/10
	=62400