Delsing Canning Company is considering an expansion of itsfacilities. Its current income statement is as follows:
| |
| Sales | $ | 5,800,000 |
| Variable costs (50% of sales) | | 2,900,000 |
| Fixed costs | | 1,880,000 |
| Earnings before interest and taxes (EBIT) | $ | 1,020,000 |
| Interest (10% cost) | | 360,000 |
| Earnings before taxes (EBT) | $ | 660,000 |
| Tax (40%) | | 264,000 |
| Earnings after taxes (EAT) | $ | 396,000 |
| Shares of common stock | | 280,000 |
| Earnings per share | $ | 1.41 |
|
The company is currently financed with 50 percent debt and 50percent equity (common stock, par value of $10). In order to expandthe facilities, Mr. Delsing estimates a need for $2.8 million inadditional financing. His investment banker has laid out threeplans for him to consider:
- Sell $2.8 million of debt at 10 percent.
- Sell $2.8 million of common stock at $20 per share.
- Sell $1.40 million of debt at 9 percent and $1.40 million ofcommon stock at $25 per share.
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Variable costs are expected to stay at 50 percent of sales,while fixed expenses will increase to $2,380,000 per year. Delsingis not sure how much this expansion will add to sales, but heestimates that sales will rise by $1 million per year for the nextfive years.
Delsing is interested in a thorough analysis of his expansion plansand methods of financing.He would like you to analyze thefollowing:
a. The break-even point for operating expensesbefore and after expansion (in sales dollars). (Enter youranswers in dollars not in millions, i.e, $1,234,567.)
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b. The degree of operating leverage before andafter expansion. Assume sales of $5.8 million before expansion and$6.8 million after expansion. Use the formula: DOL = (S −TVC) / (S − TVC − FC). (Roundyour answers to 2 decimal places.)
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c-1. The degree of financial leverage beforeexpansion. (Round your answer to 2 decimal places.)
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c-2. The degree of financial leverage for allthree methods after expansion. Assume sales of $6.8 million forthis question. (Round your answers to 2 decimalplaces.)
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d. Compute EPS under all three methods offinancing the expansion at $6.8 million in sales (first year) and$10.8 million in sales (last year). (Round your answers to2 decimal places.)
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