Question

Use the following information about Rat Race Home Security, Inc. to answer the questions: Average selling price per unit $337. Variable cost per unit $193 Units sold 433 Fixed costs $9,231 Interest expense 16,668 Based on the data above, what will be the resulting percentage change in earnings per share of Rat Race Home Security, Inc. if they expect operating profit to change -2.8 percent?

Answer 1

Units sold = 433
Selling Price per unit = $337
Variable Cost per unit = $193
Fixed Costs = $9,231
Interest Expense = $16,668

Contribution Margin = (Selling Price per unit - Variable Cost per unit) * Units sold
Contribution Margin = ($337 - $193) * 433
Contribution Margin = $62,352

EBIT = Contribution Margin - Fixed Costs
EBIT = $62,352 - $9,231
EBIT = $53,121

EBT = EBIT - Interest Expense
EBT = $53,121 - $16,668
EBT = $36,453

Degree of Financial Leverage = EBIT / EBT
Degree of Financial Leverage = $53,121 / $36,453
Degree of Financial Leverage = 1.457

Degree of Financial Leverage = % Change in EBT / % Change in EBIT
1.457 = % Change in EBT / -2.80%
% Change in EBT = -4.08%

So, if operating profit decreases by 2.80%,EPS will decrease by 4.08%