Howell Enterprises is forecasting EPS of $4.00 per share for next year. The firm has 10,000 shares outstanding, it pays 12 percent interest on its debt, and it faces a 40 percent marginal tax rate. Its estimated fixed costs are $80,000 while its variable costs are estimated at 40 percent of revenue. The firm's target capital structure is 40 percent equity and 60 percent debt and it has total assets of $400,000. On what level of sales is Howell basing its EPS forecast?
Click on the arrows to vote for the correct answer
A. B. C. D. E.B
EPS = (Sales - Fixed costs- Variable costs - Interest)(1 - T)/Shares outstanding.
Step 1 Calculate interest expense
Debt = 0.60 x $400,000 = $240,000.
Interest = 0.12 x $240,000 = $28,800.
Step 2 Solve for Sales (S)
EPS = $4.00 = (S - 0.40S - $80,000 - $28,800) x (1 - 0.40)/10,000
= (0.60S - $108,800)(0.6)/10,000
$4.00 = (0.36S - $65,280)/10,000
$105,280 = 0.36S
Sales = $292,444.44.
Alternative method -
EPS = (EBIT - Interest)(1 - T)/Shares outstanding.
Solve for EBIT -
Net Income = EPS x Shares outstanding = $4.00 x 10,000 = $40,000.
EBT = NI/(1 - T) = $40,000/(0.6) = $66,667.
Interest (from above) = $28,800.
EBIT = EBT + Interest = $66,667 + $28,800 = $95,467.
S = 0.40S + $95,467 + $80,000 -
0.6S = $175,467
S = $175,467/0.6 = $292,445.