Abbot Corp has a debt ratio (debt to assets) of 20%. Management is wondering if its current capital structure is too conservative. Abbot Corp's present EBIT is $4.5 million, and profits available to common shareholders are $2,910,600, with 600,000 shares of common stock outstanding. If the firm were to instead have a debt ratio of 40%, additional interest expense would cause profits available to stockholders to decline to $2,851,200, but only 480,000 common shares would be outstanding. What is the difference in EPS at a debt ratio of 40% versus 20%?
A) $4.85
B) $6.34
C) $1.09
D) $-0.10

Question

Quizplus · Accepted Answer

First, we need to calculate the current EPS:
EPS = Profit available to common shareholders / Number of common shares outstanding
EPS = $2,910,600 / 600,000
EPS = $4.85

Next, we need to calculate the new EPS if the company increases its debt ratio to 40%:
New EPS = Profit available to common shareholders / Number of common shares outstanding
New EPS = $2,851,200 / 480,000
New EPS = $5.94

Finally, we can calculate the difference in EPS between the two debt ratios:
Difference in EPS = New EPS - EPS
Difference in EPS = $5.94 - $4.85
Difference in EPS = $1.09

Therefore, the difference in EPS between a debt ratio of 40% and 20% is $1.09, and the correct answer is (C).

Abbot Corp Has a Debt Ratio (Debt to Assets) of 20