Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows:

Question:

Sales ..................$5,500,000

Less: Variable expense (50% of sales) ..... 2,750,000

Fixed expense............... 1,850,000

Earnings before interest and taxes (EBIT) .... 900,000

Interest (10% cost) .............. 300,000

Earnings before taxes (EBT) .......... 600,000

Tax (40%) ................. 240,000

Earnings after taxes (EAT) ......... $ 360,000

Shares of common stock—250,000 .......

Earnings per share ............ $1.44

The company is currently financed with 50 percent debt and 50 percent equity (common stock, par value of $10). In order to expand the facilities, Mr. Delsing estimates a need for $2.5 million in additional financing. His investment banker has laid out three plans for him to consider:

1. Sell $2.5 million of debt at 13 percent.

2. Sell $2.5 million of common stock at $20 per share.

3. Sell $1.25 million of debt at 12 percent and $1.25 million of common stock at $25 per share.

Variable costs are expected to stay at 50 percent of sales, while fixed expenses will increase to $2,350,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1.25 million per year for the next five years.

Delsing is interested in a thorough analysis of his expansion plans and methods of financing. He would like you to analyze the following:

a. The break-even point for operating expenses before and after expansion (in sales dollars).

b. The degree of operating leverage before and after expansion. Assume sales of $5.5 million before expansion and $6.5 million after expansion. Use the formula in footnote 2 of the chapter.

c. The degree of financial leverage before expansion and for all three methods of financing after expansion. Assume sales of $6.5 million for this question.

d. Compute EPS under all three methods of financing the expansion at $6.5 million in sales (first year) and $10.5 million in sales (last year).

e. What can we learn from the answer to part d about the advisability of the three methods of financing the expansion?

Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on... Par Value
Par value is the face value of a bond. Par value is important for a bond or fixed-income instrument because it determines its maturity value as well as the dollar value of coupon payments. The market price of a bond may be above or below par,...