Question

The Lopez-Portillo Company has $10.3 million in assets, 70 percent financed by debt and 30 percent financed by common stock. The interest rate on the debt is 12 percent and the par value of the stock is $10 per share. President Lopez-Portillo is considering two financing plans for an expansion to $16.5 million in assets.

Under Plan A, the debt-to-total-assets ratio will be maintained, but new debt will cost a whopping 14 percent! Under Plan B, only new common stock at $10 per share will be issued. The tax rate is 40 percent.

a. If EBIT is 13 percent on total assets, compute earnings per share (EPS) before the expansion and under the two alternatives. (Round your answers to 2 decimal places.)
Earnings per Share

Current ____

Plan A ____

Plan B _____

b. What is the degree of financial leverage under each of the three plans? (Round your answers to 2 decimal places.)
Degree of Financial Leverage

Current _____

Plan A______

Plan B______

c. If stock could be sold at $20 per share due to increased expectations for the firm’s sales and earnings, what impact would this have on earnings per share for the two expansion alternatives? Compute earnings per share for each. (Round your answers to 2 decimal places.)
Earnings per Share

Plan A ____

Plan B _____

Answer 1

	Given that -	Current		Plan A		Plan B
	Debt in million	7.21		11.55		7.21
	equity in million	3.09		4.95		9.29
	total asset in million	10.3		16.5		16.5
	# of share = equity / 10	309000		495000		929000
	interest rate on debt -
	7.21	12%		12%		12%
	4.34			14%
	Interest	0.87		1.47		0.87
	Values in Million except # of share and EPS
answer 1	EBIT = Asset *13%	1.34		2.15		2.15
	Int =	0.87		1.47		0.87
	EBT=EBIT-Int	0.47		0.67		1.28
	tax @40%	0.19		0.27		0.51
	PAT=EBT-Tax	0.28		0.40		0.77
	# of share	309,000		495,000		929,000
	EPS	$        0.92		$        0.81		$        0.83
answer 2	Degree of financial leverage =	2.83		3.19		1.68
	=EBIT/(EBIT-Interest)
answer 3	PAT ($million)			0.40		0.77
	Number of share(note 1)			402000		619000
	EPS			$        1.00		$        1.24
	Note -1
	Number of share
	Additional equity required/ 20			93000		310000
	Old number of share =			309000		309000
				402000		619000