Question

A firm has a EBIT indifference point of $150m and an expected EBIT of $200m with a standard deviation of $50m.

What is the z-score?

What is the probability that the firm will have a higher EPS if it uses debt?

A z-score of -1.20 would be entered as -1.20. A probability of 37.25% should be entered as 37.25.

Answer 1

Given that,

EBIT at indifference point = $150 m

expected EBIT = $200 m

Standard deviation = $50 m

So, Z score = (EBIT at indifference point - expected EBIT)/Standard deviation = (150 - 200)/50 = -1

Probability that the firm will have a higher EPS if it uses debt,

For Higher EPS, debt should be low, So at EBIT should be higher than the indifference point

So,For EBIT greater than $150m, Z>-1

Probability of Z>-1 is 84%

So, probability that the firm will have a higher EPS if it uses debt = 84%