Question

Delsing Canning Company is considering an expansion of its facilities. 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 50 percent equity (common stock, par value of $10). In order to expand the facilities, Mr. Delsing estimates a need for $2.8 million in additional financing. His investment banker has laid out three plans for him to consider:

1. Sell $2.8 million of debt at 10 percent.
2. Sell $2.8 million of common stock at $20 per share.
3. Sell $1.40 million of debt at 9 percent and $1.40 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 $2,380,000 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). (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 $5.8 million before expansion and $6.8 million after expansion. Use the formula: DOL = (S − TVC) / (S − TVC − FC). (Round your answers to 2 decimal places.)
  

c-1. The degree of financial leverage before expansion. (Round your answer to 2 decimal places.)
  

c-2. The degree of financial leverage for all three methods after expansion. Assume sales of $6.8 million for this question. (Round your answers to 2 decimal places.)
  

d. Compute EPS under all three methods of financing the expansion at $6.8 million in sales (first year) and $10.8 million in sales (last year). (Round your answers to 2 decimal places.)
  

Answer 1