Question
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 6,400,000 Variable costs (50% of sales)
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows:
Sales | $ | 6,400,000 |
Variable costs (50% of sales) | 3,200,000 | |
Fixed costs | 1,940,000 | |
Earnings before interest and taxes (EBIT) | $ | 1,260,000 |
Interest (10% cost) | 480,000 | |
Earnings before taxes (EBT) | $ | 780,000 |
Tax (40%) | 312,000 | |
Earnings after taxes (EAT) | $ | 468,000 |
Shares of common stock | 340,000 | |
Earnings per share | $ | 1.38 |
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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 $3.4 million in additional financing. His investment banker has laid out three plans for him to consider:
- Sell $3.4 million of debt at 10 percent.
- Sell $3.4 million of common stock at $20 per share.
- Sell $1.70 million of debt at 9 percent and $1.70 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 $2,440,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1.70 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.)
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b. The degree of operating leverage before and after expansion. Assume sales of $6.4 million before expansion and $7.4 million after expansion. Use the formula: DOL = (S TVC) / (S TVC FC). (Round your answers to 2 decimal places.)
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c-1. The degree of financial leverage before expansion. (Round your answers to 2 decimal places.)
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c-2. The degree of financial leverage for all three methods after expansion. Assume sales of $7.4 million for this question. (Round your answers to 2 decimal places.)
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d. Compute EPS under all three methods of financing the expansion at $7.4 million in sales (first year) and $10.3 million in sales (last year). (Round your answers to 2 decimal places.)
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