Question

Dickinson Company has $11,920,000 million in assets. Currently half of these assets are financed with long-term debt at 9.6 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 9.6 percent. The tax rate is 35 percent. Tax loss carryover provisions apply, so negative tax amounts are permissable.

Under Plan D, a $2,980,000 million long-term bond would be sold at an interest rate of 11.6 percent and 372,500 shares of stock would be purchased in the market at $8 per share and retired.

Under Plan E, 372,500 shares of stock would be sold at $8 per share and the $2,980,000 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.)
  

         

b-1. Compute the earnings per share if return on assets fell to 4.80 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 4.80 percent? Consider the current plan and the two new plans.
  

• Plan D

• Current Plan

• Plan E

  

b-3. Compute the earnings per share if return on assets increased to 14.6 percent. (Round your answers to 2 decimal places.)
  

       

       
b-4. Which plan would be most favorable if return on assets increased to 14.6 percent? Consider the current plan and the two new plans.
  

• Plan E

• Current Plan

• Plan D

c-1. If the market price for common stock rose to $10 before the restructuring, compute the earnings per share. Continue to assume that $2,980,000 million in debt will be used to retire stock in Plan D and $2,980,000 million of new equity will be sold to retire debt in Plan E. Also assume that return on assets is 9.6 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?
  

• Current Plan

• Plan E

• Plan D

Answer 1

Total Assets	11,920,000
Financed through Equity	5960000
Number of shares	745000
	Current Plan	Plan D	Plan E
EBIT	1,144,320	1,144,320	1,144,320
Less: Interest	572,160	917,840	286,080
Earnings before tax	572,160	226,480	858,240
Less: Tax @35%	200,256	79,268	300,384
Net Income	371,904	147,212	557,856
Number of shares	745,000	372,500	1,117,500
EPS	0.4992	0.3952	0.4992

b-1 Return = 4.8%
	Current Plan	Plan D	Plan E
EBIT	572,160	572,160	572,160
Less: Interest	572,160	917,840	286,080
Earnings before tax	0	-345,680	286,080
Less: Tax @35%	0	-120,988	100,128
Net Income	0	-224,692	185,952
Number of shares	745,000	372,500	1,117,500
EPS	0	-0.6032	0.1664
Plan E would be favorable

b-3 Return = 14.6%
	Current Plan	Plan D	Plan E
EBIT	1,740,320	1,740,320	1,740,320
Less: Interest	572,160	917,840	286,080
Earnings before tax	1,168,160	822,480	1,454,240
Less: Tax @35%	408,856	287,868	508,984
Net Income	759,304	534,612	945,256
Number of shares	745,000	372,500	1,117,500
EPS	1.0192	1.4352	0.845867
Plan D would be favorable

c-1
	Current Plan	Plan D	Plan E
EBIT	1,144,320	1,144,320	1,144,320
Less: Interest	572,160	917,840	286,080
Earnings before tax	572,160	226,480	858,240
Less: Tax @35%	200,256	79,268	300,384
Net Income	371,904	147,212	557,856
Number of shares	745,000	447,000	1,043,000
EPS	0.4992	0.329333	0.534857
Plan E would be favorable