Question

DELSING CANNING COMPANY IS CONSIDERING AN EXPANSION OF ITS FACILITIES. ITS CURRENT INCOME STATEMENT IS AS FOLLOWS:

SALES............................................................................ 7,100,100
VARIABLE COSTS (50% OF SALES).............................3,550,000
FIXED COSTS.................................................................2,010,000
EBIT.................................................................................1,540,000
INTEREST (10% COST)....................................................620,000
EBT.....................................................................................920,000
TAX (30%)..........................................................................276,000
EAT.....................................................................................644,000
SHARES COMMON STOCK..............................................410,000
EPS...........................................................................................1.57

The company is currently financed with 50% debt and 50% equity (common stock, par value of $10). In order to expand the facilities, Mr. Delsing estimates a need for $4.1 million in additional financing. His investment banker has laid out three plans for him to consider:
1) Sell $4.1 million of debt at 11%
2) Sell $4.1 million of common stock at $20 per share
3) Sell $2.05 million of debt at 10% and $2.05 million of common stock at $25 per share.

Variable costs are expected to stay at 50% of sales, while fixed expenses will increase to $2,510,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates sales will rise by $2.05 million per year for the next 5 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). ENTER YOUR ANSWERS IN DOLLARS NOT IN MILLIONS, I.E. $1,234,567.

	BREAK-EVEN POINT
BEFORE EXPANSION
AFTER EXPANSION

b. The degree of operating leverage before and after expansion. Assume sales of $7.1 million before expansion, and $8.1 million after expansion. Use the formula
DOL = (S - TVC) / (S - TVC - FC). ROUND YOUR ANSWERS TO 2 DECIMAL PLACES.

	DEGREE OF OPERATING LEVERAGE
BEFORE EXPANSION
AFTER EXPANSION

c. The degree of financial leverage before expansion. ROUND YOUR ANSWERS TO 2 DECIMAL PLACES.

d. The degree of financial leverage for all three methods after expansion. Assume sales of $8.1 million for this question. ROUND YOUR ANSWERS TO 2 DECIMAL PLACES.

	DEGREE OF FINANCIAL LEVERAGE
100 % DEBT
100% EQUITY
50% DEBT & 50% EQUITY

e. Compute EPS under all three methods of financing the expansion at $8.1 million in sales (first year) and $11.0 million in sales (last year). ROUND ANSWERS TO 2 DECIMAL PLACES.

	EPS
	FIRST YEAR	LAST YEAR
100% DEBT
100% EQUITY
50% DEBT & 50% EQUITY

Answer 1

a	Before Expansion
	Contribution Margin ratio	CM/Sales *100
		3550100/7100100*100
		50%
	Break Even Point-Before Expansion	FC/Contribution margin ratio
		2010000/50%
		4020000
	Break Even Point After Expansion
	New Variable Cost	50%*9150100=4575050
	New Sales	7100100+2050000
		9150100
	New FC	2510000
	Contribution Margin	9150100-4575050
		4575050/9150100*100
		50%
	Break Even Point-After Expansion	FC/Contribution Margin
		2510000/50%
		1255000
b	Degree of Operating Leverage	Contribution Margin/Operating Income
	Before Expansion	3550100/1540100
		2.305
	After Expansion	4575050/2065050
		2.215
c	The degree of financial leverage before expansion	EBIT/EBIT-Interest
		1540000/1540000-620000
		1540000/920000
		1.67
d	The degree of financial leverage After expansion
	100% Debt	1540000/1540000-(620000+451000)	3.284
	100% Equity	1540000/920000	1.67
	50% Debt ,50% Equity	1540000/1540000-(620000+205000)	2.154