Question
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 7,400,000 Variable costs (50% of sales)
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows:
Sales | $ | 7,400,000 |
Variable costs (50% of sales) | 3,700,000 | |
Fixed costs | 2,040,000 | |
Earnings before interest and taxes (EBIT) | $ | 1,660,000 |
Interest (10% cost) | 680,000 | |
Earnings before taxes (EBT) | $ | 980,000 |
Tax (30%) | 294,000 | |
Earnings after taxes (EAT) | $ | 686,000 |
Shares of common stock | 440,000 | |
Earnings per share | $ | 1.56 |
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 $4.4 million in additional financing. His investment banker has laid out three plans for him to consider:
- Sell $4.4 million of debt at 14 percent.
- Sell $4.4 million of common stock at $20 per share.
- Sell $2.20 million of debt at 13 percent and $2.20 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 $2,540,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $2.20 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 $7.4 million before expansion and $8.4 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 $8.4 million for this question. (Round your answers to 2 decimal places.)
c. If stock could be sold at $20 per share due to increased expectations for the firms sales and earnings, what impact would this have on earnings per share for the two expansion alternatives? Compute earnings per share for each. (Round your answers to 2 decimal places.)
d. Compute EPS under all three methods of financing the expansion at $8.4 million in sales (first year) and $10.2 million in sales (last year). (Round your answers to 2 decimal places.)
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