In: Finance
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 |
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 |