Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows:
Sales $ 7,300,000
Variable costs (50% of sales) 3,650,000
Fixed costs 2,030,000
Earnings before interest and taxes (EBIT) 1,620,000
Interest (10% cost) 660,000
Earnings before taxes (EBT) $ 960,000
Tax (40%) 384,000
Earnings after taxes (EAT) $ 576,000
Shares of common stock 430,000
Earnings per share $ 1.34
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 $4.3 million in additional financing. His investment banker has laid out three plans for him to consider:
Sell $4.3 million of debt at 13 percent.
Sell $4.3 million of common stock at $25 per share.
Sell $2.15 million of debt at 12 percent and $2.15 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 $2,530,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1 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 $7.3 million before expansion and $8.3 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 answer to 2 decimal places.)
c-2. The degree of financial leverage for all three methods after expansion. Assume sales of $8.3 million for this question. (Round your answers to 2 decimal places.)
d. Compute EPS under all three methods of financing the expansion at $8.3 million in sales (first year) and $10.1 million in sales (last year). (Round your answers to 2 decimal places.)