Question

Harris Inc. has EBIT of $1,500 and debt of $5,000 on which it pays 12% interest. Its EPS is currently $2.35 per share. Management anticipates a difficult period ahead and fears EBIT could decline by as much as 20%. What will the new EPS be if that happens?

Answer 1

Answer:

Ans. The new EPS be if that happens will be $1.57

Explanation:

Hi, first let´s introduce the equation we need to find the EPS.

$EPS=\frac{((EBIT-Int)(1-Tax)}{Shares}$

And since we know that the next EBIT will decline by 20%, our new EBIT will be 80% of the initial EBIT, so we solve the last equation for (1-tax) and we get the following 2 equations.

$(1-Tax)=\frac{EPS(1)*Shares}{(EBIT-Int)}$

$(1-Tax)=\frac{EPS(2)*Shares}{(0.8*EBIT-Int)}$

Our interest expense (Int) is $5,000*0.12= $600, EBIT is 1,500, 0.8*EBIT=1,200, EBIT(1)=$2.35, so we solve for EPS(2) the followiong equation.

$\frac{EPS(2)*Shares}{(0.8*EBIT-Int)}=\frac{EPS(1)*Shares}{(EBIT-Int)}$

$\frac{EPS(2)}{(0.8*EBIT-Int)}=\frac{EPS(1)}{(EBIT-Int)}$

$EPS(2)=\frac{EPS(1)*(0.8*EBIT-Int)}{(EBIT-Int)}$

$EPS(2)=\frac{2.35*(1,200-600)}{(1,500-600)} =\frac{1,410}{900} =1.57$

Therefore, our new EPS if the company´s EBIT drops by 20% would be $ 1.57.

Best of luck.