Question
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 5,300,000 Variable costs (50% of sales)
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 5,300,000 Variable costs (50% of sales) 2,650,000 Fixed costs 1,830,000 Earnings before interest and taxes (EBIT) $ 820,000 Interest (10% cost) 260,000 Earnings before taxes (EBT) $ 560,000 Tax (30%) 168,000 Earnings after taxes (EAT) $ 392,000 Shares of common stock 230,000 Earnings per share $ 1.70
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 $2.3 million in additional financing. His investment banker has laid out three plans for him to consider:
1.Sell $2.3 million of debt at 11 percent.
2.Sell $2.3 million of common stock at $25 per share.
3.Sell $1.15 million of debt at 10 percent and $1.15 million of common stock at $40 per share.
Variable costs are expected to stay at 50 percent of sales, while fixed expenses will increase to $2,330,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1.15 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.) |
Break-Even Point | |
Before expansion | $ |
After expansion | $ |
b. | The degree of operating leverage before and after expansion. Assume sales of $5.3 million before expansion and $6.3 million after expansion. Use the formula: DOL = (S ? TVC) / (S ? TVC ? FC).(Round your answers to 2 decimal places.) |
Degree of Operating Leverage | ||
Before expansion | ||
After expansion | ||
c-1. | The degree of financial leverage before expansion. (Round your answers to 2 decimal places.) |
Degree of financial leverage |
c-2. | The degree of financial leverage for all three methods after expansion. Assume sales of $6.3 million for this question. (Round your answers to 2 decimal places.) |
Degree of Financial Leverage | ||
100% Debt | ||
100% Equity | ||
50% Debt & 50% Equity | ||
d. | Compute EPS under all three methods of financing the expansion at $6.3 million in sales (first year) and $10.3 million in sales (last year).(Round your answers to 2 decimal places.) |
Earnings per share | ||
First year | Last year | |
100% Debt | $ | $ |
100% Equity | ||
50% Debt & 50% Equity |
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