mr gold is in the widget businesd. He currently sells 1 million
widgets a year at $5 each. His variable cost to produce the widgets is
$3 per unit, and he has $1,500,000 in fixed cost. His sales-to-assets
ratio is five times, and 40 percent of his assets are financed with 8
percnet debt, with the balance financed by common stock at $10 per
share. The tax rate is 40 percent.
Mr. silverman, says he is doing it all wrong. By reducing hIS price to
$4.50 a widget, he could increase his volume of units sold by 40
percent. Fixed costs would remain constant and variable costs would
remain $3 per unit. His sales-to-asset ratio would be 6.3 times.
Furthermore, he could increase his debt-to-assets ratio to 50 percent,
with the balance in common stock. It is assumed that the interest rate
would go up by 1 percent and the price of stock would remain constant.

Compute earnings per share under the Silverman plan.
Mr Gold's wife, does not think that fixed costs would remain constant
under the Silverman plan but that they would go up by 15 percent. If
this is the case, should Mr. Gold shift to the Silverman plan based on
earnings per share?

I HAVE TO ANSWER BEFORE 5PM TODAY!!!!!!

SILVERMAN PLAN


Sales = 1.4 million units @ $4.50 = $6.3 million

Assets (at 6.3:1) = $1,000,000

Bonds  (50%) = $500,000
Stock = $500,000 = 50,000 shares

Contribution margin (at $1.50 per widget) = $2,100,000
Fixed cost = $1,725,000 (15% increase over $1.5 million)

EARNINGS BEFORE INTEREST + TAXES (EBIT) = $375,000

Bond payments (9%) = $45,000
Taxes = ($375,000 - $45,000) * 0.40 = $132,000

NET INCOME = $198,000

EARNINGS PER SHARE (EPS) = $198,000/50,000 shares = $3.96


Though there are fewer shares outstanding, EPS declines from the
original $4.68  ? not a good thing.  Note that the critical assumption
made late in the problem ? that fixed costs increase by 15% or
$225,000 is what kills this proposition.

If Silverman were correct and fixed costs DID remain constant, EBIT
would be $600,000; and net income would be $333,000 or $6.66.

Best regards,

Omnivorous-GA

Great!!! Thanks