Problem 5-27 Expansion, break-even analysis, and leverage [LO2, 3, 4]

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

Sales	$	7,400,000
Less: Variable expense (50% of sales)		3,700,000
Fixed expense		2,040,000
Earnings before interest and taxes (EBIT)		1,660,000
Interest (10% cost)		680,000
Earnings before taxes (EBT)		980,000
Tax (30%)		294,000
Earnings after taxes (EAT)	$	686,000
Shares of common stock		440,000
Earnings per share	$	1.56

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 $4.4 million in additional financing. His investment banker has laid out three plans for him to consider:

1.Sell $4.4 million of debt at 14 percent.

2.Sell $4.4 million of common stock at $20 per share.

3.Sell $2.20 million of debt at 13 percent and $2.20 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 $2,540,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $2.20 million per year for the next five years. Delsing is interested in a thorough analysis of his expansion plans and methods of financing.

(a)	The break-even point for operating expenses before and after expansion. (Enter your answers in dollars not in millions. Omit the "$" sign in your response.)

	Break-even point
Before expansion	$
After expansion	$

(b)	The degree of operating leverage before and after expansion. Assume sales of $7.4 million before expansion and $8.4 million after expansion. (Enter only numeric values rounded to 2 decimal places.)

	Degree of operating leverage
Before expansion
After expansion

(c-1)

The degree of financial leverage before expansion. (Enter only numeric value rounded to 2 decimal places.)

Degree of financial leverage

(c-2)

The degree of financial leverage for all three methods after expansion. Assume sales of $8.4 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 $8.4 million in sales (first year) and $10.2 million in sales (last year). (Round your answers to 2 decimal places. Omit the "$" sign in your response.)

Earnings per share	First year	Last year
100% Debt	$	$
100% Equity
50% Debt & 50% Equity