Lever Brothers has a debt ratio (debt to assets)of 60%.Management is wondering if its current capital structure is too aggressive.Lever Brothers's present EBIT is $3 million,and profits available to common shareholders are $1,440,000,with 228,571 shares of common stock outstanding.If the firm were to instead have a debt ratio of 20%,reduced interest expense would cause profits available to stockholders to increase to $1,680,000,but 457,143 common shares would be outstanding.What is the difference in EPS at a debt ratio of 20% versus 60%?

Question

Quizplus · Accepted Answer

First, let's calculate EPS at the current debt ratio of 60%:

EPS = Profits available to common shareholders / Number of shares outstanding
EPS = $1,440,000 / 228,571
EPS = $6.30

Now, let's calculate EPS at the proposed debt ratio of 20%:

EPS = Profits available to common shareholders / Number of shares outstanding
EPS = $1,680,000 / 457,143
EPS = $3.68

The difference in EPS is:

$6.30 - $3.68 = $2.62

Therefore, the answer is B, $-2.63. The EPS would decrease by $2.63 if the company moves from a debt ratio of 60% to 20%.

Lever Brothers Has a Debt Ratio (Debt to Assets)of 60