10:36 smu.brightspace.com - Private Variable costs: 30% of revenue Fixed costs: $1,000,000 Depreciation: $475,000 Bond Issue A: $300,000 face value, 10% coupon Bond Issue B: $500,000 face value, 8% coupon Bond Issue C: $900,000 face value, 12% coupon Tax rate: 40% Common shares issued and Outstanding: 250,000 a. Calculate the degree of operating leverage for the firm. (2 marks) b. Calculate the degree of financial leverage for the firm. (2 marks) c. Calculate the degree of combined leverage for the firm. (2 marks) d. If the company is able to increase their sales by 15%, what percentage increase in EPS would you expect to observe? (2 marks) e. If the company's sales increase by 15%, what will the new EPS be? (2 marks) f. If the company's sales decrease by 12%, what will the new EPS be? (2 marks) g. If EBIT increases by 5%, what will the new EPS be? (2 marks) h. If the company's sales decrease by 7%, what will the new EBIT be? (2 marks) FINA3361 A3 Page 1 Problem #4 (16 marks) Harden Hardware Limited is considering a change to its current capital structure. The current capital structure (Plan I) is all equity with 210,000 common shares outstanding. Under Plan II, the company would issue debt to buy back shares, leaving 150,000 shares of common stock outstanding and $2,280,000 in debt at an interest rate of 8%. The tax rate is 40% a) If EBIT is $500,000, Which plan will result in the highest EPS? Show your work. (4 marks) b) If EBIT is $750,000, Which plan will result in the highest EPS? Show your work. (4 marks) c) Calculate the breakeven EBIT for each plan. (2 marks) d) Calculate the indifference EBIT (4 marks) e) Calculate EPS for each plan at this level of EBIT (2 marks) Problem #5 (19 marks) Rene's Renovations Inc. is planning a major expansion program requiring $5,000,000 in financing. Option #1: Rene's may sell bonds with an 8% coupon rate, or Option #2: Rene's may sell 200,000 shares of common stock to get the needed funds. After the expansion there is a 30% probability of EBIT (Earnings Before Interest and Taxes) being $2 million, a 50% probability of EBIT being $3 million and a 20% probability of EBIT being $4 million. The following data was taken from the firm's pre-expansion income statement: Interest expense $100,000 Tax Rate 40% Common shares outstanding 300,000 a) Calculate the EPS based on the expected EBIT under each alternative. (5 marks) b) Which plan would you chose at this level of EBIT? (1 mark) c) Which option will have the higher DFL (Degree of Financial Leverage - no calculation required)? (1 mark) d) What level of EBIT would yield the same EPS for the stock and debt alternatives? (5 marks) e) What EPS corresponds to this level of EBIT? (2 marks) Instead of Option #2 (issuing 200,000 common shares), if the company decided they should issue only 100,000 common shares at $25 each and finance the remainder of the project with 3% preferred shares, what would the indifference point be? (5 marks) Problem #6 (5 marks) Florence Flooring Limited is considering two different financing plans. 1. Under plan I the interest would be 8% on $100,000 face value bonds. 2. Under plan II the interest would be $10,125 with 1,400 shares of common stock outstanding. If the indifference point is $25,000 and the tax rate is 30%, how many shares of common stock are outstanding for plan I? FINA3361 A3 Page 2 II + 2 12 :1 0>> Reflect in ePortfolio10:36 smu.brightspace.com - Private Problem #1 (4 marks) The Markham Machine Corporation requires $85 million to finance an expansion. The company will sell new common shares via a general cash offering to raise the required funds. If the offer price is $16 per share and the company's underwriters charge an 8% spread, how many shares need to be sold? Problem #2 (4 marks) Bookers Bakery Limited is taking their company public. Under this firm commitment offering, Bookers Bakery will receive $16.67 from the Underwriter (DFG Capital Markets) for each of the 1,500,000 shares that will be issued. You purchased 1,000 shares at the initial offering price of $19.00 per share from your friend who is a broker at DFG. Additional legal fees of $500,000 and indirect costs of $125,000 have been incurred. What are the flotation costs as a percentage of the total funds raised? Problem #3 (16 marks) Below is Income Statement information for Claire's Cabinets Limited Revenue: $3,107,262 Variable costs: 30% of revenue Fixed costs: $1,000,00 Depreciation: $475,000 Bond Issue A: $300,000 face value, 10% coupon Bond Issue B: $500,000 face value, 8% coupon Bond Issue C: $900,000 face value, 12% coupon Tax rate: 40% Common shares issued and Outstanding: 250,000 a. Calculate the degree of operating leverage for the firm. (2 marks) b. Calculate the degree of financial leverage for the firm. (2 marks) c. Calculate the degree of combined leverage for the firm. (2 marks) d. If the company is able to increase their sales by 15%, what percentage increase in EPS would you expect to observe? (2 marks) e. If the company's sales increase by 15%, what will the new EPS be? (2 marks) f. If the company's sales decrease by 12%, what will the new EPS be? (2 marks) g. If EBIT increases by 5%, what will the new EPS be? (2 marks) h. If the company's sales decrease by 7%, what will the new EBIT be? (2 marks) FINA3361 A3 Page 1 Problem #4 (16 marks) Harden Hardware Limited is considering a change to its current capital structure. The current capital structure (Plan I) is all equity with 210,000 common shares outstanding. Under Plan II, the company would issue debt to buy back shares, leaving 150,000 shares of common stock outstanding and $2,280,000 in debt at an interest rate of 8%. The tax rate is 40% a) If EBIT is $500,000, Which plan will result in the highest EPS? Show your work. (4 marks) b) If EBIT is $750,000, Which plan will result in the highest EPS? Show your work. (4 marks) c) Calculate the breakeven EBIT for each plan. (2 marks) d) Calculate the indifference EBIT (4 marks) e) Calculate EPS for each plan at this level of EBIT (2 marks) Problem #5 (19 marks) Rene's Renovations Inc. is planning a major expansion program requiring $5,000,000 in financing. Option #1: Rene's may sell bonds with an 8% coupon rate, or Option #2: Rene's may sell 200,000 shares of common stock to get the needed funds. After the expansion there is a 30% probability of EBIT (Earnings Before Interest and Taxes) being $2 million, a 50% probability of EBIT being $3 million and a 20% probability of EBIT being $4 million. The following data was taken from the firm's pre-expansion income statement: Interest expense $100,000 Tax Rate 40% Common shares outstanding 300,000 a) Calculate the EPS based on the expected EBIT under each alternative. (5 marks) b) Which plan would you chose at this level of EBIT? (1 mark) c) Which option will have the higher DFL (Degree of Financial Leverage - no calculation required)? (1 mark) d) What level of EBIT would yield the same EPS for the stock and debt alternatives? (5 marks) e) What EPS corresponds to this level of EBIT? (2 marks) f) Instead of Option #2 (issuing 200,000 common shares), if the company decided they should issue only 100,000 common shares at $25 each and finance the remainder of the project with 3% preferred shares, what would the indifference point be? (5 marks) Problem #6 (5 marks) Florence Flooring Limited is considering two different financing plans. II 1 12 HD >> Reflect in ePortfolio