A firm is currently expected to develop $2 EPS when operating income equals $4 million and interest expense equals $2 million.How low can operating income drop before EPS are reduced by half,to $1? Ignore taxes.
A) Operating income drops to $3.5 million.
B) Operating income drops to $3.0 million.
C) Operating income drops to $2.5 million.
D) Operating income drops to $2.0 million.

Question

Quizplus · Accepted Answer

The firm currently has a net income of $2 million ($4 million operating income - $2 million interest expense) and EPS of $2.

To reduce EPS by half, the firm needs to have a net income of $1 million and assuming the interest expense remains constant at $2 million, the operating income required to achieve this net income is:

$1 million + $2 million = $3 million

Therefore, the operating income can drop to $3 million before EPS are reduced to $1.

Option B is the closest to the calculated amount, which makes it the best choice.

A Firm Is Currently Expected to Develop $2 EPS When