A corporation reports sales of $3,000,000, variable costs of $1,000,000, fixed o

Question

A corporation reports sales of $3,000,000, variable costs of $1,000,000, fixed operating costs of $750,000, and interest expense of $250,000. The corporation's EBIT is $2,250,000 and its marginal tax rate is 30%. If the corporation is able to increase its sales by 25%, then
Answer
a. its EBIT will increase by 25% and its EPS will increase by 25%. b. its EBIT will increase by more than 25% and its EPS will increase by less than 25%. c. its EBIT will increase by more than 25% and its EPS will increase by more than the percentage increase in EBIT. d. its EBIT and EPS will both increase, but less than 25% due to fixed costs and taxes.

Explanation / Answer

sales $3,000,000 Less var costs ($1,000,000) ---------------------------------- Total Contn $2,000,000 Less FC ($750,000) ----------------------------- EBIT $1250,000 Less Int ($250,000) ---------------------- EBT $1000,000 Less Tax 30% ($333,000) ------------------------------- PAT $667,000 ................................(A) When sales Increase by 25%: sales 1.25*$3,000,000 = $3750,000 Less var costs (1.25*$1,000,000) =($1250,000) ---------------------------------- Total Contn $2,500,000 Less FC ($750,000) .......will not change ----------------------------- EBIT $1750,000 Less Int ($250,000) ---------------------- EBT $1500,000 Less Tax 30% ($500,000) ------------------------------- PAT $1,000,000 .................................(B) SO Change in EBIT = (1750,000-1250,000)/1250,000 = 40% Change in PAT = (1000,000-667,000)/667000 = 50% SO answer is c. its EBIT will increase by more than 25% and its EPS will increase by more than the percentage increase in EBIT.

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