Question

Dickinson Company has $11,800,000 million in assets. Currently half of these assets are financed with long-term debt at 9.0 percent and half with common stock having a par value of $8. Ms. Smith, Vice President of Finance, wishes to analyze two refinancing plans, one with more debt (D) and one with more equity (E). The company earns a return on assets before interest and taxes of 9.0 percent. The tax rate is 35 percent. Tax loss carryover provisions apply, so negative tax amounts are permissible.

Under Plan D, a $2,950,000 million long-term bond would be sold at an interest rate of 11.0 percent and 368,750 shares of stock would be purchased in the market at $8 per share and retired.

Under Plan E, 368,750 shares of stock would be sold at $8 per share and the $2,950,000 in proceeds would be used to reduce long-term debt.

a. How would each of these plans affect earnings per share? Consider the current plan and the two new plans. (Round your answers to 2 decimal places.)

Current Plan	Plan D	Plan E

b-1. Compute the earnings per share if return on assets fell to 4.50 percent. (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.)

b-2. Which plan would be most favorable if return on assets fell to 4.50 percent? Consider the current plan and the two new plans.
  

• Plan E

• Current Plan

• Plan D

  

b-3. Compute the earnings per share if return on assets increased to 14.0 percent. (Round your answers to 2 decimal places.)

b-4. Which plan would be most favorable if return on assets increased to 14.0 percent? Consider the current plan and the two new plans. Current Plan Plan D Plan

E c-1. If the market price for common stock rose to $10 before the restructuring, compute the earnings per share. Continue to assume that $2,950,000 million in debt will be used to retire stock in Plan D and $2,950,000 million of new equity will be sold to retire debt in Plan E. Also assume that return on assets is 9.0 percent. (Round your answers to 2 decimal places.)

c-2. If the market price for common stock rose to $10 before the restructuring, which plan would then be most attractive? Plan D Current Plan Plan E

Answer 1

	Current Plan	Plan D	Plan E
EBIT	1,062,000	1,062,000	1,062,000
Less: Interest	531,000	855,500	265,500
Earnings before tax	531,000	206,500	796,500
Less: Tax @35%	185,850	72,275	278,775
Net Income	345,150	134,225	517,725
Number of shares	737,500	368,750	1,106,250
EPS	0.4680	0.3640	0.4680

If return falls to 4.5%

	Current Plan	Plan D	Plan E
EBIT	531,000	531,000	531,000
Less: Interest	531,000	855,500	265,500
Earnings before tax	0	-324,500	265,500
Less: Tax @35%	0	-113,575	92,925
Net Income	0	-210,925	172,575
Number of shares	737,500	368,750	1,106,250
EPS	0.0000	-0.5720	0.1560

Plan E would be most favorable

Return increased to 14%
	Current Plan	Plan D	Plan E
EBIT	1,652,000	1,652,000	1,652,000
Less: Interest	531,000	855,500	265,500
Earnings before tax	1,121,000	796,500	1,386,500
Less: Tax @35%	392,350	278,775	485,275
Net Income	728,650	517,725	901,225
Number of shares	737,500	368,750	1,106,250
EPS	0.9880	1.4040	0.8147

Plan D would be most favorable

Market Price rose
	Current Plan	Plan D	Plan E
EBIT	1,062,000	1,062,000	1,062,000
Less: Interest	531,000	855,500	265,500
Earnings before tax	531,000	206,500	796,500
Less: Tax @35%	185,850	72,275	278,775
Net Income	345,150	134,225	517,725
Number of shares	737,500	442,500	1,032,500
EPS	0.4680	0.3033	0.5014

Plan E