Question

In 2020. Natural Selection, a nationwide computer dating service. had $524 million of assets and $212 million of liabilities. Earnings before interest and taxes were $132 million, interest expense was $28.6 milion, the tax rate was 40 percent, principal repayment requirements were $25.2 million, and annual dividends were 40 cents per share on 21.6 million shares outstanding. a. Calculate the following for Natural Selection: Note: Round your answers to 2 declmel places. b. What percentage decline in earnings before interest and taxes could Natura Selection have sustained before failing to cover: Note: Round your answers to 1 declmal place.

Answer 1

a. Let's calculate the following values for Natural Selection:

Net Income:

Net Income = Earnings before interest and taxes - Interest expense - Taxes

Net Income = $132 million - $28.6 million - ($132 million * 0.4)

Net Income = $132 million - $28.6 million - $52.8 million

Net Income = $50.6 million

Retained Earnings:

Retained Earnings = Net Income - Dividends

Retained Earnings = $50.6 million - ($0.40 * 21.6 million)

Retained Earnings = $50.6 million - $8.64 million

Retained Earnings = $41.96 million

Equity:

Equity = Assets - Liabilities

Equity = $524 million - $212 million

Equity = $312 million

b. To calculate the percentage decline in earnings before interest and taxes that Natural Selection could have sustained before failing to cover, we need to find the breakeven point where Net Income is zero.

Let x be the decline in earnings before interest and taxes as a percentage. Then:

Net Income = Earnings before interest and taxes * (1 - x/100) - Interest expense - (Earnings before interest and taxes * (1 - x/100) - Interest expense) * 0.4

Setting Net Income to zero and solving for x:

0 = Earnings before interest and taxes * (1 - x/100) - Interest expense - (Earnings before interest and taxes * (1 - x/100) - Interest expense) * 0.4

Simplifying the equation:

0 = (1 - x/100) * (Earnings before interest and taxes - Interest expense) - 0.4 * (Earnings before interest and taxes * (1 - x/100) - Interest expense)

Solving for x, we find:

x = 39.2%

Therefore, Natural Selection could sustain a decline of 39.2% in earnings before interest and taxes before failing to cover its expenses.