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

If the current EPS is $2 and operating income is $4 million, then the firm has 2 million shares outstanding. 
Thus, current net income = $4 million - $2 million = $2 million. 
To reduce the EPS to $1, the firm has to reduce net income to $1 million. 
Using the formula for EPS: EPS = (net income/number of shares outstanding), we can solve for the new operating income: 
$1 = ($1 million/2 million shares) 
$1 million = 2 million shares * $1 
Thus, the operating income required to achieve a $1 EPS is $3 million. 
Therefore, operating income can drop by $1 million (from $4 million to $3 million) before EPS is reduced by half to $1.

A Firm Is Currently Expected to Develop $2 EPS When