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Colorado Equipment is evaluating two financing options to raise $10 million for an expansion project. Colorado...

Colorado Equipment is evaluating two financing options to raise $10 million for an expansion project. Colorado Equipment can borrow money from a bank and the interest rate will be 8%, or Colorado Equipment can issue one million common stocks for $10 per share.

The company currently has 2.5 million common shares.

Without the new financing, the projected income statement of Colorado Equipment is shown below.

The earnings per share for Colorado Equipment are: 1.03 under public issue and 1.95 under bank.

Determine the break-even EBIT between the two financing options. If Colorado Equipment expects an EBIT of $7.4 million in 2017, will it be beneficial to increase leverage?

Sales Revenue 30,253

Operating Expenses 14,740

Earnings from Resort Operations 15,513

Administration 2,719

Marketing/Promotion 941

Miscellaneous 302

Earnings before Interest, Depreciation & Amortization (EBITDA) 11,550

Depreciation 2,682

Amortization of Goodwill 324

Earnings before Interest & Taxes (EBIT) 8,543

Interest 2,718

Earnings before Taxes (EBT) 5,826

Taxes @ 38% .... 2214

Net Income 3,612

Dividends 1,047

Increase (Decrease) in Retained Earnings 2,564

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Expert Solution

Sales Revenue 30,253
Operating Expenses 14,740
Earnings from Resort Operations 15,513
Administration 2,719
Marketing/Promotion 941
Miscellaneous 302
Earnings before Interest, Depreciation & Amortization (EBITDA) 11,550
Depreciation 2,682
Amortization of Goodwill 324
Earnings before Interest & Taxes (EBIT) 8,543
Interest 2,718
Earnings before Taxes (EBT) 5,826
Taxes @ 38% 2,214
Net Income 3,612
Dividends 1,047
Increase (Decrease) in Retained Earnings 2,564
Shares Outstanding in Mn 2.5
Shares Outstanding in '000 2500
EPS 1.4448
Tax rate 38%
Breakeven EBIT i..e EBIT at which EPS remians constant under different financing options
Public Issue method >> Interest expense same as above
EPS 1.03
Interest Expense 2,718
Tax Rate 38%
Shares Outstanding in '000 3,500 2.5mn existing + 1mn new
Breakeven EBIT = EPS/(1-Tax rate) + Interest Exp           8,533 Public Issue
Bank Financing >> Interest expense increases
EPS 1.95
Interest Expense 3518 =10000*8%+2718
Tax Rate 38%
Shares Outstanding in '000 2500
Breakeven EBIT = EPS/(1-Tax rate) + Interest Exp        11,381 Bank Financing
At EBIT of 7.4mn, EPS will decline. So increasing leverage is not a good choice from EPS perspective

jeff jeffy answered 2 years ago
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