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chapter 14 Create an Excel spreadsheet to organize your answers to the following problem, and submit...
chapter 14
Create an Excel spreadsheet to organize your answers to the
following problem, and submit your Excel file as an attachment by
clicking on the appropriate button on this page.
A company with EBIT of $6,000,000 is considering two financing
alternatives. The first alternative would have $25 million of bonds
at 8% interest and 1,000,000 common shares outstanding, whereas the
second would have $47.5 million of bonds at 8% interest and only
750,000 shares outstanding. The company is in the 35% tax
bracket.
Part 1: Construct the bottom half of the income statement
(including EPS) for each financing alternative when EBIT is at
$6,000,000.
Part 2: Construct the bottom half of the income statement
(including EPS) for each alternative if EBIT increases by
20%.
Part 3: Construct the bottom half of the income statement
(including EPS) for each alternative if EBIT decreases by
20%.
Part 4: What is the EBIT/EPS indifference point for this
firm?
Part 5: Comment on the results of your calculations above.
What principle does this exercise demonstrate?
Solutions
Expert Solution
| Part 1 | |||
| a | Statement of profit and loss | ||
| Amount ($) | |||
| Earnings before interest and tax | 6,000,000 | ||
| Finance costs | 2,000,000 | ||
| Earnings before taxes | 4,000,000 | ||
| Tax expenses | 1,400,000 | ||
| Earnings after tax | 2,600,000 | ||
| Earnings per share- | |||
| Shares outstanding | 1,000,000 | ||
| Basic EPS | 2.60 | ||
| b | Statement of profit and loss | ||
| Amount ($) | |||
| Earnings before interest and tax | 6,000,000 | ||
| Finance costs | 3,800,000 | ||
| Earnings before taxes | 2,200,000 | ||
| Tax expenses | 770,000 | ||
| Earnings after tax | 1,430,000 | ||
| Earnings per share- | |||
| Shares outstanding | 750,000 | ||
| Basic EPS | 1.91 | ||
| Part 2 | |||
| a | Statement of profit and loss | ||
| Amount ($) | |||
| Earnings before interest and tax | 7,200,000 | ||
| Finance costs | 2,000,000 | ||
| Earnings before taxes | 5,200,000 | ||
| Tax expenses | 1,820,000 | ||
| Earnings after tax | 3,380,000 | ||
| Earnings per share- | |||
| Shares outstanding | 1,000,000 | ||
| Basic EPS | 3.38 | ||
| b | Statement of profit and loss | ||
| Amount ($) | |||
| Earnings before interest and tax | 7,200,000 | ||
| Finance costs | 3,800,000 | ||
| Earnings before taxes | 3,400,000 | ||
| Tax expenses | 1,190,000 | ||
| Earnings after tax | 2,210,000 | ||
| Earnings per share- | |||
| Shares outstanding | 750,000 | ||
| Basic EPS | 2.95 | ||
| Part 3 | |||
| a | Statement of profit and loss | ||
| Amount ($) | |||
| Earnings before interest and tax | 4,800,000 | ||
| Finance costs | 2,000,000 | ||
| Earnings before taxes | 2,800,000 | ||
| Tax expenses | 980,000 | ||
| Earnings after tax | 1,820,000 | ||
| Earnings per share- | |||
| Shares outstanding | 1,000,000 | ||
| Basic EPS | 1.82 | ||
| b | Statement of profit and loss | ||
| Amount ($) | |||
| Earnings before interest and tax | 4,800,000 | ||
| Finance costs | 3,800,000 | ||
| Earnings before taxes | 1,000,000 | ||
| Tax expenses | 350,000 | ||
| Earnings after tax | 650,000 | ||
| Earnings per share- | |||
| Shares outstanding | 750,000 | ||
| Basic EPS | 0.87 | ||
| Part 4. | 4million EBIfT and 100,000 shares in part b is indif | ferent point for EPS. | |
| a | Statement of profit and loss | ||
| Amount ($) | |||
| Earnings before interest and tax | 4,000,000 | ||
| Finance costs | 2,000,000 | ||
| Earnings before taxes | 2,000,000 | ||
| Tax expenses | 700,000 | ||
| Earnings after tax | 1,300,000 | ||
| Earnings per share- | |||
| Shares outstanding | 1,000,000 | ||
| Basic EPS | 1.30 | ||
| b | Statement of profit and loss | ||
| Amount ($) | |||
| Earnings before interest and tax | 4,000,000 | ||
| Finance costs | 3,800,000 | ||
| Earnings before taxes | 200,000 | ||
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