Question
Problem 5-27 (Algo) Expansion, break-even analysis, and leverage [LO5-2, 5-3, 5-4] Delsing Canning Company is considering an expansion of its facilities. Its current income statement
Problem 5-27 (Algo) Expansion, break-even analysis, and leverage [LO5-2, 5-3, 5-4]
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows:
Sales | $ 6,800,000 |
---|---|
Variable costs (50% of sales) | 3,400,000 |
Fixed costs | 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 |
Earnings per share | $ 1.58 |
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 $3.8 million in additional financing. His investment banker 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. 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).
Note: 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 $6.8 million before expansion and $7.8 million after expansion. Use the formula: DOL=(STVC)(STVCFC)DOL=S-TVCS-TVC-FC .
Note: Round your answers to 2 decimal places.
c-1. The degree of financial leverage before expansion.
Note: Round your answer to 2 decimal places.
c-2. The degree of financial leverage for all three methods after expansion. Assume sales of $7.8 million for this question.
Note: Round your answers to 2 decimal places.
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).
Note: Round your answers to 2 decimal places.
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