A Bristal Boats,Inc.reports sales of $4,000,000,variable costs of $500,000,fixed operating costs of $1,250,000,and interest expense of $350,000.The corporation's EBIT is $3,250,000 and its marginal tax rate is 30%.If the corporation is able to increase its sales by 25%,then
A)its EBIT will increase by 25% and its EPS will increase by 25%.
B)its EBIT will increase by more than 25% and its EPS will increase by less than 25%.
C)its EBIT and EPS will both increase,but less than 25% due to fixed costs and taxes.
D)its EBIT will increase by more than 25% and its EPS will increase by more than the percentage increase in EBIT.

Question

Quizplus · Accepted Answer

Increasing sales by 25% will result in an increase in revenue of $1,000,000 (25% of $4,000,000). Since the company has a contribution margin of 87.5% ($3,500,000/$4,000,000), an increase in revenue of $1,000,000 will result in an increase in EBIT of $875,000 ($1,000,000 x 87.5%). Therefore, the new EBIT will be $4,125,000 ($3,250,000 + $875,000). After deducting interest expense of $350,000 and taxes at 30%, the new net income will be $2,172,500. This represents an increase in EPS of 21.3% ($2,172,500/$3,250,000), which is less than the increase in EBIT of 26.9% ($875,000/$3,250,000). Therefore, the correct answer is D.