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Phelps Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $6,800,000 Less: Variable expense (50% of sales)

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

Sales $6,800,000
Less: Variable expense (50% of sales) 3,400,000
Fixed expense 1,980,000
Earnings before interest and taxes (EBIT) 1,420,000
Interest (10% cost) 560,000
Earnings before taxes (EBT) 860,000
Tax (30%) 258,000
Earnings after taxes (EAT) $602,000
Shares of common stock 380,000
EPS $1.58

Phelps Canning Company is currently financed with 50 percent debt and 50 percent equity (common stock). To expand facilities, Mr. Phelps estimates a need for $3.8 million in additional financing. His investment dealer has laid out three plans for him to consider:

  1. Sell $3.8 million of debt at 14 percent.
  2. Sell $3.8 million of common stock at $20 per share.
  3. Sell $1.90 million of debt at 13 percent and $1.90 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 $2,480,000 per year. Mr. Phelps is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1.90 million per year for the next five years.

Mr. Phelps 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 the answers in dollars not in millions.)

Break-even point
Before expansion $
After expansion $

b. The DOL before and after expansion. Assume sales of $6.8 million before expansion and $7.8 million after expansion. (Round the final answers to 2 decimal places.)

DOL
Before expansion X
After expansion X

c-1. The DFL before expansion at sales of $6.8 million. (Round the final answers to 2 decimal places.)

DFL X

c-2. The DFL for all three methods after expansion. Assume sales of $7.8 million. (Round the final answers to 2 decimal places.)

DFL
100% Debt X
100% Equity X
50% Debt & 50% Equity X

d. Compute EPS under all three methods of financing the expansion at $7.8 million in sales (first year) and $10.7 million in sales (last year). (Round the final answers to 2 decimal places.)

EPS First year Last year
100% Debt $ $
100% Equity
50% Debt & 50% Equity

e. Not available in Connect.

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