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

          

 
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 $2.5 million in additional financing. His investment banker has laid out three plans for him to consider:

 
1. Sell $2.5 million of debt at 13 percent.

 
2. Sell $2.5 million of common stock at $20 per share.

 
3. Sell $1.25 million of debt at 12 percent and $1.25 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 $2,350,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1.25 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).

 
b. The degree of operating leverage before and after expansion. Assume sales of $5.5 million before expansion and $6.5 million after expansion. Use the formula in footnote 2 of the chapter.

 
c. The degree of financial leverage before expansion and for all three methods of financing after expansion. Assume sales of $6.5 million for this question.

 
d. Compute EPS under all three methods of financing the expansion at $6.5 million in sales (first year) and $10.5 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?

Sales $5,500,000 Less: Variable expense (50% of sales).. Fixed expense 2,750,000 1,850,000 ...................... Earnings before interest and taxes (EBIT) Interest (10% cost) Earnings before taxes (EBT) Tax (40%). Earnings after taxes (EAT) $ 900,000 300,000 $ 600,000 240,000 $ 360,000 Shares of common stock-250,000 Earnings per share $1.44