(CMA adapted.) The Virgil Company is planning to invest \(\$ 10\) million in an expansion program that is expected to increase income before interest and taxes by \(\$ 2.5\) million. Currently. Virgil Company has total equities of \(\$ 40\) million, 25 percent of which is debt and 75 percent of which is shareholders' equity, represented by 1 million shares. The expansion can be financed with the issuance of 200.000 new shares at \(\$ 50\) each or by issuing long-term debt at an annual interest rate of 10 percent. The following is an excerpt from the most recent income statement.

Assume that Virgil Company maintains its current earnings on its present assets, achieves the planned earnings from the new program, and that the tax rate remains at 40 percent.
a What will be earnings per share if the expansion is financed with debt?
b What will be earnings per share if the expansion is financed by issuing new shares?
c At what level of earnings before interest and taxes will earnings per share be the same, whichever of the two financing programs is used?
d At what level of earnings before interest and taxes will the rate of return on shareholders' equity be the same, whichever of the two financing plans is used?

Transcribed Image Text:

Earnings Before Interest and Taxes. Less: Interest Charges Earnings Before Income Taxes Income Taxes (at 40 percent) Net Income $10,500,000 500,000 $10,000,000 4,000,000 $ 6,000,000