Question
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 5,800,000 Variable costs (50% of sales)
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows:
Sales | $ | 5,800,000 |
Variable costs (50% of sales) | 2,900,000 | |
Fixed costs | 1,880,000 | |
Earnings before interest and taxes (EBIT) | $ | 1,020,000 |
Interest (10% cost) | 360,000 | |
Earnings before taxes (EBT) | $ | 660,000 |
Tax (40%) | 264,000 | |
Earnings after taxes (EAT) | $ | 396,000 |
Shares of common stock | 280,000 | |
Earnings per share | $ | 1.41 |
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 $2.8 million in additional financing. His investment banker has laid out three plans for him to consider:
- Sell $2.8 million of debt at 10 percent.
- Sell $2.8 million of common stock at $20 per share.
- Sell $1.40 million of debt at 9 percent and $1.40 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 $2,380,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1.40 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). (Enter your answers in dollars not in millions, i.e, $1,234,567.)
b. The degree of operating leverage before and after expansion. Assume sales of $5.8 million before expansion and $6.8 million after expansion. Use the formula: DOL = (S TVC) / (S TVC FC). (Round your answers to 2 decimal places.)
c-1. The degree of financial leverage before expansion. (Round your answers to 2 decimal places.)
c-2. The degree of financial leverage for all three methods after expansion. Assume sales of $6.8 million for this question. (Round your answers to 2 decimal places.)
d. Compute EPS under all three methods of financing the expansion at $6.8 million in sales (first year) and $10.8 million in sales (last year). (Round your answers to 2 decimal places.)
Break-Even Point Before expansion After expansion Degree of Operating Leverage Before expansion After expansion Degree of Financial Leverage 100% Debt 100% Equity 50% Debt & 50% Equity Earnings per Share First Year Last Year 100% Debt 100% Equity 50% Debt & 50% EquityStep by Step Solution
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