Problem: Mr. Gold is in the widget business. He now sells 1.1 million widgets a year at $8 each. His variable cost to produce the widgets is $6 per unit, and he has $1,730,000 in fixed costs. His sales-to-assets ratio is eight times, and 40 percent of his assets are financed with 8 percent debt, with balance financed by common stock at $10 par value per share. The tax rate is 35 percent.
His brother-in-law, Mr. Silverman, says he is doing it all incorrect. By decreasing his price to $7.50 a widget, he could raise his volume of units sold by 60 percent. Fixed costs would remain stable, and variable costs would remain $6 per unit. His sales-to-assets ratio would be 11.0 times. Additionally, he could raise his debt-to-assets ratio to 50 percent, with the balance in common stock. It is supposed that the interest rate would go up by 1 percent and the price of stock would remain stable.
(a) Evaluate earnings per share under the Gold plan.
(b) Evaluate earnings per share under the Silverman plan.