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

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

Less: Variable expense (50% of sales) ............. 2,500,000

Fixed expense .......................................................... 1,800,000

Earnings before interest and taxes (EBIT) ....... 700,000

Interest (10% cost) .................................................... 200,000

Earnings before taxes (EST) .................................. 500,000

Tax (34%). . .......... .. . ...................................... .. .. . . 170,000

Earnings after taxes (EAT) .................................. $ 330,000

Shares of common stock......................................... 200,000

EPS ..................................................................................... $1.65

Phelps Canning Company is currently financed with 50 percent debt and 50 percent equity (common stock). To expand facilities, Mr. Phelps estimates a need for $2 million in additional financing. His investment dealer has laid out three plans for him to consider:

1. Sell $2 million of debt at 13 percent.

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

3. Sell $1 million of debt at 12 percent and $1 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 $2,300,000 per year. Mr. Phelps is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1 million per year for the next five years. Mr. Phelps 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 DOL before and after expansion. Assume sales of $5 million before expansion and $6 million after expansion.

c. The DFL before expansion at sales of $5 million and for all three methods of financing after expansion. Assume sales of $6 million for the second part of this question.

d. Compute EPS under all three methods of financing the expansion at $6 million in sales (first year) and $10 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? Make your selection of the financing method that best suits Mr. Phelps' objective of maximizing shareholders' wealth.