A firm currently has operating income of $4 million,interest expense of $2 million,and EPS of $2.How low can operating income drop before EPS are reduced by half,to $1? Ignore taxes.
A) $3.5 million
B) $3.0 million
C) $2.5 million
D) $2.0 million

Question

Quizplus · Accepted Answer

First, we need to use the formula for EPS:

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

We know that the current EPS is $2. We want to find the level of operating income where EPS is reduced by half to $1.

$1 = (Operating Income - $2 million) / Number of Shares

Multiplying both sides by the number of shares, we get:

Number of Shares = Operating Income - $2 million

We want to solve for the minimum level of operating income that makes this equation true.

$1 = (Operating Income - $2 million) / (Operating Income - $2 million)

$1 = 1

This means that the minimum level of operating income that makes EPS reduce to $1 is when operating income is equal to interest expense:

Operating Income = $2 million

If operating income drops below $2 million, EPS will be less than $1.

Therefore, we can conclude that the answer is B) $3.0 million.

A Firm Currently Has Operating Income of $4 Million,interest Expense