Question

Kiwi Airlines has fixed operating costs of $5.8 million, and its variable costs amount to 20 percent of sales revenue. The firm has $2 million in bonds outstanding with a coupon interest rate of 8 percent. Revenues for the firm are $8 million and the firm is in the 40 percent corporate income tax bracket. How will a 10 percent increase in operating income affect earnings per share?

Answer 1

Hi

Here Operating Income = Sales - variable cost - fixed cost

=8,000,000 - 5,800,000 - 20%*8,000,000

=$600,000

Income befor tax= 600,000 - 2,000,000*8%

= $440,000

Net Income = 440,000-440,000*40%

=$264,000

Now if EBIT increases by 10%

new EBIT = 600,000*(1+10%)  

=$660,000

Income before tax = 660,000 - 2,000,000*8%

= $500,000

Net Income = 500,000*(1-40%)

= $300,000

Change in earning per share will be same as change in net income

hence change in earning per share = New net income -old net income/old net income

=(300,000-264,000)/264,000

= 13.63%

Thanks