Question
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 6,800,000 Variable costs (50% of sales)
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: |
| |
Sales | $ | 6,800,000 |
Variable costs (50% of sales) |
| 3,400,000 |
Fixed costs |
| 1,980,000 |
Earnings before interest and taxes (EBIT) | $ | 1,420,000 |
Interest (10% cost) |
| 560,000 |
Earnings before taxes (EBT) | $ | 860,000 |
Tax (30%) |
| 258,000 |
Earnings after taxes (EAT) | $ | 602,000 |
Shares of common stock |
| 380,000 |
Earnings per share | $ | 1.58 |
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 $3.8 million in additional financing. His investment banker has laid out three plans for him to consider:
Sell $3.8 million of debt at 14 percent.
Sell $3.8 million of common stock at $20 per share.
Sell $1.90 million of debt at 13 percent and $1.90 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 $2,480,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1.90 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 $6.8 million before expansion and $7.8 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 $7.8 million for this question. (Round your answers to 2 decimal places.)
d. Compute EPS under all three methods of financing the expansion at $7.8 million in sales (first year) and $10.7 million in sales (last year). (Round your answers to 2 decimal places.)
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started