Question

Dickinson Company has $12,080,000 million in assets. Currently half of these assets are financed with long-term debt at 10.4 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 10.4 percent. The tax rate is 40 percent. Tax loss carryover provisions apply, so negative tax amounts are permissable.

Under Plan D, a $3,020,000 million long-term bond would be sold at an interest rate of 12.4 percent and 377,500 shares of stock would be purchased in the market at $8 per share and retired.

Under Plan E, 377,500 shares of stock would be sold at $8 per share and the $3,020,000 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

Earnings per share _____, ______, _____.

b-1. Compute the earnings per share if return on assets fell to 5.20 percent. (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.)
  

Current Plan, Plan D, Plan E

Earnings per share _____, ______, _____.

        

b-2. Which plan would be most favorable if return on assets fell to 5.20 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 15.4 percent. (Round your answers to 2 decimal places.)
  

  

Current Plan, Plan D, Plan E

Earnings per share _____, ______, _____.

      

       
b-4. Which plan would be most favorable if return on assets increased to 15.4 percent? Consider the current plan and the two new plans.
  

	Plan D
	Current Plan
	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 $3,020,000 million in debt will be used to retire stock in Plan D and $3,020,000 million of new equity will be sold to retire debt in Plan E. Also assume that return on assets is 10.4 percent. (Round your answers to 2 decimal places.)
  

  

Current Plan, Plan D, Plan E

Earnings per share _____, ______, _____.

       

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

	Plan D
	Plan E
	Current Plan

Answer 1

a	How would each of these plans affect earnings per share? Consider the current plan and the two new plans
				Current Plan	Plan D	Plan E
	EBIT	(12080000*10.40%)		1256320	1256320	1256320
	Less : Interest			628160	1002640	314080
				(12080000/2)*10.40%	(3020000*12.40%)+628160	(6040000-3020000)*10.40%		6040000
	EBT			628160	253680	942240
	Less : Taxes @ 40%			251264	101472	376896
	Earnings after tax			376896	152208	565344
	Common Shares			755000	377500	1132500
				(12080000/2)/8	(755000-377500)	(755000+377500)
	EPS			0.50	0.40	0.50
b-1	Compute the earnings per share if return on assets fell to 5.20 percent.
				Current Plan	Plan D	Plan E
	EBIT	(12080000*5.20%)		628160	628160	628160
	Less : Interest			628160	1002640	314080
				(12080000/2)*10.40%	(3020000*12.40%)+628160	(6040000-3020000)*10.40%
	EBT			0	-374480	314080
	Less : Taxes @ 40%			0	-149792	125632
	Earnings after tax			0	-224688	188448
	Common Shares			755000	377500	1132500
				(12080000/2)/8	(755000-377500)	(755000+377500)
	EPS			0.00	-0.60	0.17
b-2	Which plan would be most favorable if return on assets fell to 5.20 percent? Consider the current plan and the two new plans.
	Plan E would be favorable as it has higher EPS
b-3	Compute the earnings per share if return on assets increased to 15.4 percent
				Current Plan	Plan D	Plan E
	EBIT	(12080000*15.40%)		1860320	1860320	1860320
	Less : Interest			628160	1002640	314080
				(12080000/2)*10.40%	(3020000*12.40%)+628160	(6040000-3020000)*10.40%
	EBT			1232160	857680	1546240
	Less : Taxes @ 40%			492864	343072	618496
	Earnings after tax			739296	514608	927744
	Common Shares			755000	377500	1132500
				(12080000/2)/8	(755000-377500)	(755000+377500)
	EPS			0.98	1.36	0.82
b-4	Which plan would be most favorable if return on assets increased to 15.4 percent? Consider the current plan and the two new plans.
	Plan D would be favorable as it has higher EPS
c-1	If the market price for common stock rose to $10 before the restructuring, compute the earnings per share. Continue to assume that $3,020,000 million in debt will be used to retire stock in Plan D and $3,020,000 million of new equity will be sold to retire debt in Plan E. Also assume that return on assets is 10.4 percent.
				Current Plan	Plan D	Plan E
	EBIT	(12080000*10.40%)		1256320	1256320	1256320
	Less : Interest			628160	1002640	314080
				(12080000/2)*10.40%	(3020000*12.40%)+628160	(6040000-3020000)*10.40%
	EBT			628160	253680	942240
	Less : Taxes @ 40%			251264	101472	376896
	Earnings after tax			376896	152208	565344
	Common Shares			755000	453000	1057000
				(12080000/2)/10	755000-(3020000/10)	755000+(3020000/10)
	EPS			0.50	0.34	0.53
c-2	If the market price for common stock rose to $10 before the restructuring, which plan would then be most attractive?
	Plan E would be most attractive because it has higher EPS