In: Finance
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 5,700,000 Variable costs (50% of sales) 2,850,000 Fixed costs 1,870,000 Earnings before interest and taxes (EBIT) $ 980,000 Interest (10% cost) 340,000 Earnings before taxes (EBT) $ 640,000 Tax (35%) 224,000 Earnings after taxes (EAT) $ 416,000 Shares of common stock 270,000 Earnings per share $ 1.54 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 $2.7 million in additional financing. His investment banker has laid out three plans for him to consider: Sell $2.7 million of debt at 9 percent. Sell $2.7 million of common stock at $25 per share. Sell $1.35 million of debt at 8 percent and $1.35 million of common stock at $30 per share. Variable costs are expected to stay at 50 percent of sales, while fixed expenses will increase to $2,370,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1.35 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 $5.7 million before expansion and $6.7 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 answers to 2 decimal places.) c-2. The degree of financial leverage for all three methods after expansion. Assume sales of $6.7 million for this question. (Round your answers to 2 decimal places.) d. Compute EPS under all three methods of financing the expansion at $6.7 million in sales (first year) and $10.7 million in sales (last year). (Round your answers to 2 decimal places.)
a) | |||
At break-even before expansion | |||
Break Even point = FC + VC = Break Even Sales | |||
Sales = $1,870,000 + .50 Sales | |||
.50 Sales = $1,870,000 | |||
Sales = $1,870,000 / .50 | $3,740,000.00 | ||
At break-even after expansion | |||
Break Even point = FC + VC = Break Even Sales | |||
Sales = $2,370,000 + .50 Sales | |||
.50 Sales = $2,370,000 | |||
Sales = $2,370,000 / .50 | $4,740,000.00 | ||
b) | |||
Before Expansion | |||
DOL = (S ? TVC) / (S ? TVC ? FC) | |||
DOL = (5,700,000 - 2,850,000)/( 5,700,000 - 2,850,000 - 1,870,000) | 2.91 | ||
After Expansion | |||
DOL = (S ? TVC) / (S ? TVC ? FC) | |||
DOL = (6,700,000 - 3,350,000)/( 6,700,000 - 3,350,000 - 2,370,000) | 3.42 | ||
c) 1 | |||
DFL before expansion: | |||
DFL = EBIT/ EBIT - Interest | |||
DFL = $980,000/$980,000 - $340,000 | 1.53 | ||
c) 2 | |||
DFL after expansion | |||
Compute EBIT and Interest for all three plans | 100% Debt | 100% equity | (50% Debt and50% Equity) |
Sales | $6,700,000.00 | $6,700,000.00 | $6,700,000.00 |
Less Variable Cost | $3,350,000.00 | $3,350,000.00 | $3,350,000.00 |
Less Fixed Cost | $2,370,000.00 | $2,370,000.00 | $2,370,000.00 |
EBIT | $980,000.00 | $980,000.00 | $980,000.00 |
Interest on old debt | $340,000.00 | $340,000.00 | $340,000.00 |
Interest on New debt (2.7M x 9%); (1.35 M x 8%) | $243,000.00 | $0.00 | $108,000.00 |
Total Interest | $583,000.00 | $340,000.00 | $448,000.00 |
DF = EBIT/(EBIT - Interest) | 2.47 | 1.53 | 1.84 |
d) | 100% Debt | 100% equity | (50% Debt and50% Equity) |
Sales | $6,700,000.00 | $6,700,000.00 | $6,700,000.00 |
Less Variable Cost | $3,350,000.00 | $3,350,000.00 | $3,350,000.00 |
Less Fixed Cost | $2,370,000.00 | $2,370,000.00 | $2,370,000.00 |
EBIT | $980,000.00 | $980,000.00 | $980,000.00 |
Less: Interest | $583,000.00 | $340,000.00 | $448,000.00 |
EBT | $397,000.00 | $640,000.00 | $532,000.00 |
Less: Tax @ 35% | $138,950.00 | $224,000.00 | $186,200.00 |
Net Income | $258,050.00 | $416,000.00 | $345,800.00 |
Shares Outstanding | |||
Old Shares Outstanding | 270000 | 240000 | 240000 |
New Shares Outstanding | 0 | 108000 | 45000 |
Net Shares Outstanding ($2.7M/$25),($1.35M/$30) | 270000 | 348000 | 285000 |
EPS = Net Income/ Shares Outstanding | $0.96 | $1.20 | $1.21 |
d) | 100% Debt | 100% equity | (50% Debt and50% Equity) |
Sales | $10,700,000.00 | $10,700,000.00 | $10,700,000.00 |
Less Variable Cost | $5,350,000.00 | $5,350,000.00 | $5,350,000.00 |
Less Fixed Cost | $2,370,000.00 | $2,370,000.00 | $2,370,000.00 |
EBIT | $2,980,000.00 | $2,980,000.00 | $2,980,000.00 |
Less: Interest | $583,000.00 | $340,000.00 | $448,000.00 |
EBT | $2,397,000.00 | $2,640,000.00 | $2,532,000.00 |
Less: Tax @ 35% | $838,950.00 | $924,000.00 | $886,200.00 |
Net Income | $1,558,050.00 | $1,716,000.00 | $1,645,800.00 |
Shares Outstanding | |||
Old Shares Outstanding | 270000 | 240000 | 240000 |
New Shares Outstanding | 0 | 108000 | 45000 |
Net Shares Outstanding ($2.7M/$25),($1.35M/$30) | 270000 | 348000 | 285000 |
EPS = Net Income/ Shares Outstanding | $5.77 | $4.93 | $5.77 |