ASG expects next year's operating income (EBIT) to equal $22 million, with a standard deviation of $16 million. The coefficient of variation of operating income is equal to 0.73. Interest expenses will be $9 million next year and debt retirement will require a principal payment of $2.5 million. ASG's marginal tax rate is 40%. If EBIT is normally distributed, what is the probability that ASG will have a negative EPS next year? (Problem requires a normal distribution table.)
A) 20.9%
B) 25.5%
C) 23.3%
D) 25.8%

Question

Quizplus · Accepted Answer

The correct answer is A.The coefficient of variation is the standard deviation divided by the mean. In this case, the coefficient of variation is 0.73, so the standard deviation is 0.73 * $22 million = $16 million.The mean EBIT is $22 million, and the interest expense is $9 million. The debt retirement payment is $2.5 million. The marginal tax rate is 40%.The probability of having a negative EPS is the probability that EBIT is less than $11.5 million.The z-score for EBIT of $11.5 million is (11.5 - 22) / 16 = -0.66.The probability of having a z-score of -0.66 or less is 20.9%.

ASG Expects Next Year's Operating Income (EBIT) to Equal $22