A firm is currently expected to develop $2 EPS when operating income equals $4 million and interest expense equals $2 million.How low can operating income drop before EPS is reduced by half, to $1? Ignore taxes.

Question

Quizplus · Accepted Answer

To find the answer, we need to use the formula for EPS:

EPS = (Operating Income - Interest Expense) / Number of Shares

We know that when operating income is $4 million and interest expense is $2 million, EPS is $2. We also know that we want EPS to be reduced by half, to $1.

So:

$1 = (Operating Income - Interest Expense) / Number of Shares

We can rearrange this equation to solve for Operating Income:

Operating Income = $1 x Number of Shares + Interest Expense

We don't know the number of shares, but that doesn't matter because we're only interested in how much operating income can drop. We can set the number of shares to 1 to simplify the calculation:

Operating Income = $1 x 1 + $2 million

Operating Income = $3 million

So operating income can drop to $3 million before EPS is reduced by half. The only option that is lower than $3 million is B, operating income drops to $3.0 million.

A Firm Is Currently Expected to Develop $2 EPS When