Mr. Gold is in the widget business. He currently sells 1.7 million widgets a yea
ID: 2731431 • Letter: M
Question
Mr. Gold is in the widget business. He currently sells 1.7 million widgets a year at $7 each. His variable cost to produce the widgets is $5 per unit, and he has $1,680,000 in fixed costs. His sales-to-assets ratio is seven times, and 40 percent of his assets are financed with 9 percent debt, with the balance financed by common stock at $10 par value per share. The tax rate is 40 percent.
His brother-in-law, Mr. Silverman, says he is doing it all wrong. By reducing his price to $6.00 a widget, he could increase his volume of units sold by 40 percent. Fixed costs would remain constant, and variable costs would remain $5 per unit. His sales-to-assets ratio would be 8.0 times. Furthermore, he could increase his debt-to-assets ratio to 50 percent, with the balance in common stock. It is assumed that the interest rate would go up by 1 percent and the price of stock would remain constant.
Compute earnings per share under the Gold plan.
Compute earnings per share under the Silverman plan.
Mr. Gold is in the widget business. He currently sells 1.7 million widgets a year at $7 each. His variable cost to produce the widgets is $5 per unit, and he has $1,680,000 in fixed costs. His sales-to-assets ratio is seven times, and 40 percent of his assets are financed with 9 percent debt, with the balance financed by common stock at $10 par value per share. The tax rate is 40 percent.
His brother-in-law, Mr. Silverman, says he is doing it all wrong. By reducing his price to $6.00 a widget, he could increase his volume of units sold by 40 percent. Fixed costs would remain constant, and variable costs would remain $5 per unit. His sales-to-assets ratio would be 8.0 times. Furthermore, he could increase his debt-to-assets ratio to 50 percent, with the balance in common stock. It is assumed that the interest rate would go up by 1 percent and the price of stock would remain constant.
Compute earnings per share under the Gold plan.
Compute earnings per share under the Silverman plan.
Explanation / Answer
Gold Plan Silver Plan Sales in units 1,700,000 2380000 Sales in $ 11900000 14280000 Costs: Variable cost 8500000 11900000 Fixed cost 1680000 1680000 Total Cost 10180000 13580000 Operating profit 1720000 700000 Interest 61200 102000 Profit before tax 1658800 598000 Tax at 40% 663520 239200 Profit after tax 995280 358800 EPS (PAT/102000) 9.76 3.52 Workings for debt and equity values and no of shares: Sales to Assets ratio 7 8 Total Assets 1700000 2040000 Debt 680000 1020000 Equity 1020000 1020000 Par value of share $10 $10 No of Shares 102000 102000
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