Question

Edsel Research Labs has $29.20 million in assets. Currently half of these assets are financed with long-term debt at 10 percent and half with common stock having a par value of $10. Ms. Edsel, the 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 percent. The tax rate is 40 percent.

Under Plan D, a $7.30 million long-term bond would be sold at an interest rate of 9 percent and 730,000 shares of stock would be purchased in the market at $10 per share and retired. Under Plan E, 730,000 shares of stock would be sold at $10 per share and the $7,300,000 in proceeds would be used to reduce long-term debt.

a-1. 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.)

a-2. Which plan(s) would produce the highest EPS? Note that due to tax loss carry-forwards and carry-backs, taxes can be a negative number.

Plan D

The Current Plan and Plan E

Plan E

Current Plan

b. Which plan would be most favorable if return on assets increased to 15 percent? Compare the current plan and the two new plans.

Current Plan

Plan D

Plan E

Current Plan and Plan D

c. Assuming return on assets is back to the original 10 percent, but the interest rate on new debt in Plan D is 5 percent, which of the three plans will produce the highest EPS?

Plan D

The plans Current and E

Plan E

The Plan Current and D

Answer 1

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