Question 2.A.15: Calculate the indifference point between the low-geared and ...

Financial Management for Decision Makers

Calculate the indifference point between the low-geared and the high-geared financing options.

The blue check mark means that this solution has been answered and checked by an expert. This guarantees that the final answer is accurate.
Learn more on how we answer questions.

Once again, let x be the operating profit at which the two financing options provide the same earnings per share.

	Low-geared option	High-geared option
	£m	£m
Operating profit	x	x
Interest payable	(10.0)	(30.0)
Profit before taxation	(x – 10.0)	(x – 30.0)
Tax (20%)	0.2(x – 10.0)	0.2(x – 30.0)
Profit after tax	0.8(x – 10.0)	0.8(x – 30.0)
Earnings per share	$\frac{0.8(x – £10.0m)}{300.0m}$	$\frac{0.8(x – £30.0m)}{100.0m}$

Thus, earnings per share under each financing option will be equal when:

$\frac{0.8(x – £10.0m)}{300.0m} = \frac{0.8(x – £30.0m)}{100.0m}$

The above equation can be solved as follows:

80x – £800m = 240x – £7,200m

\quad \quad \quad x       =      £ \underline{40.0m}

Related Answered Questions

Question: 2.SAQ.1

Quardis Ltd is a small business that imports high-quality laser printers. The most recent statement of financial position of the business is as follows: ...

Verified Answer:

Quardis Ltd (a) The projected income statement for...

Question: 2.RQ.1

In what ways might projected financial statements help a business that is growing fast? ...

Verified Answer:

When a business is growing fast, it is vital that ...

Question: 2.RQ.2

‘The future is uncertain and so projected financial statements will almost certainly prove to be inaccurate. It is, therefore, a waste of time to prepare them.’ Comment. ...

Verified Answer:

It is true that the future is uncertain. It is als...

Question: 2.RQ.3

Why is the sales forecast normally critical to the preparation of projected financial statements? ...

Verified Answer:

The sales forecast is critical because it will det...

Question: 2.RQ.4

Distinguish between financial gearing and operating gearing. Why do businesses often avoid having high levels of both financial and operating gearing? ...

Verified Answer:

Financial gearing arises from the presence of fixe...

Question: 2.SE.1

Choice Designs Ltd operates a wholesale/retail carpet store. The statement of financial position of the business as at 31 May Year 8 is as follows: ...

Verified Answer:

Choice Designs Ltd (a) The projected income statem...

Question: 2.SE.5

Semplice Ltd manufactures catering equipment for restaurants and hotels. The statement of financial position of the business as at 31 May Year 4 is as follows: ...

Verified Answer:

Semplice Ltd (a) Projected income statement for th...

Question: 2.SE.4

The financial statements of Danube Engineering plc for the year that has just ended are as follows: ...

Verified Answer:

Danube Engineering plc Projected income statem...

Question: 2.A.22

What steps might managers of a business take to reduce: (a) the level of financial gearing, and (b) the level of operating gearing where it is considered to be too high? ...

Verified Answer:

Managers may lower levels of financial gearing by ...

Question: 2.A.21

Calculate the degree of operating gearing for Strategy 2 at the different levels of sales output mentioned in Example 2.7. ...

Verified Answer:

Strategy 2 £m £m £m £m £m Sales 30.00 40.00 5...