Question
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:
- Sell $3.8 million of debt at 14 percent.
- Sell $3.8 million of common stock at $20 per share.
- 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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