Question

In: Finance

Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as...

Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows:

Sales $ 6,100,000
Variable costs (50% of sales) 3,050,000
Fixed costs 1,910,000
Earnings before interest and taxes (EBIT) $ 1,140,000
Interest (10% cost) 420,000
Earnings before taxes (EBT) $ 720,000
Tax (40%) 288,000
Earnings after taxes (EAT) $ 432,000
Shares of common stock 310,000
Earnings per share $ 1.39

The company is currently financed with 50 percent debt and 50 percent equity (common stock, par value of $10). In order to expand the facilities, Mr. Delsing estimates a need for $3.1 million in additional financing. His investment banker has laid out three plans for him to consider:

  1. Sell $3.1 million of debt at 13 percent.
  2. Sell $3.1 million of common stock at $20 per share.
  3. Sell $1.55 million of debt at 12 percent and $1.55 million of common stock at $25 per share.

Variable costs are expected to stay at 50 percent of sales, while fixed expenses will increase to $2,410,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1 million per year for the next five years.
Delsing is interested in a thorough analysis of his expansion plans and methods of financing.He would like you to analyze the following:


a. The break-even point for operating expenses before and after expansion (in sales dollars). (Enter your answers in dollars not in millions, i.e, $1,234,567.)

Break-Even Point  

Before expansion ___________

After expansion ___________


b. The degree of operating leverage before and after expansion. Assume sales of $6.1 million before expansion and $7.1 million after expansion. Use the formula: DOL = (STVC) / (STVC − FC). (Round your answers to 2 decimal places.)
  

Degree of Operating Leverage

Before expansion ________________

After expansion _________________


c-1. The degree of financial leverage before expansion. (Round your answer to 2 decimal places.)
  

Degree of financial leverage ___________


c-2. The degree of financial leverage for all three methods after expansion. Assume sales of $7.1 million for this question. (Round your answers to 2 decimal places.)
  

Degree of financial leverage

100% debt ___________________

100% equity ___________________

50% debt and 50% equity ________________

d. Compute EPS under all three methods of financing the expansion at $7.1 million in sales (first year) and $10.0 million in sales (last year). (Round your answers to 2 decimal places.)
  

Earnings per share

First Year Last Year

100% debt _________________________________

100% Equity _________________________________

50%debt and 50% equity ______________________________

Solutions

Expert Solution

Please do Upvote if you are served. Feel free to reach out in the comments

Cheers!!!

Answer(a):

Existing After Expansion
Sales                      6,100,000                      7,650,000
Variable Cost (50% of Sales)                      3,050,000                      3,825,000
Contribution                      3,050,000                      3,825,000
Contribution Margin Ration                                    50                                    50
Fixed Cost                      1,910,000                      2,410,000
EBIT                      1,140,000                      1,415,000
Interest (10% cost)                          420,000
EBT                          720,000
Tax (40%)                          288,000
EAT                          432,000
Shares of common stock                          310,000
EPS                                 1.39
Break Even point in dollars Fixed Cost / Contribution margin Ratio
= 1910000/50% 2410000/50%
= 3,820,000 4,820,000

Answer(b):

Existing After Expansion
Sales (S)                6,100,000                7,100,000
Variable Cost (50% of Sales) (TVC)                3,050,000                3,550,000
Contribution (S - TVC)                3,050,000                3,550,000
Contribution Margin Ration                               50                               50
Fixed Cost (FC)                1,910,000                2,410,000
EBIT (S-TVC-FC)                1,140,000                1,140,000
DOL= (S-TVC)/(S-TVC-FC)
DOL= 3050000/1140000 3550000/1140000
DOL= 2.68 3.11

Answer (c1):

Sales (S)              6,100,000
Variable Cost (50% of Sales) (TVC)              3,050,000
Contribution (S - TVC)              3,050,000
Contribution Margin Ration                            50
Fixed Cost (FC)              1,910,000
EBIT (S-TVC-FC)              1,140,000
Interest (10% cost)                  420,000
EBT                  720,000
DFL= EBIT /EBT
= 1140000/720000
= 1.58

Answer(c2):

Method 1 Method 2 Method 3
100% debt 100% equity 50% Equity 50% Debt
Sales (S)                                7,100,000              7,100,000                                7,100,000
Variable Cost (50% of Sales) (TVC)                                3,550,000              3,550,000                                3,550,000
Contribution (S - TVC)                                3,550,000              3,550,000                                3,550,000
Contribution Margin Ration                                               50                            50                                               50
Fixed Cost (FC)                                2,410,000              2,410,000                                2,410,000
EBIT (S-TVC-FC)                                1,140,000              1,140,000                                1,140,000
Interest                                    823,000                  420,000 606000
(420000+(3100000*13%)) (420000+(1550000*12%))
EBT                                    317,000                  720,000                                    534,000
DFL= EBIT /EBT
= 1140000/317000 1140000/720000 1140000/534000
=                                           3.60                         1.58                                           2.13

Answer(d):

d. Method 1 Method 2 Method 3
100% debt 100% equity 50% Equity 50% Debt
1st year last year 1st year last year 1st year last year
Sales (S)                                7,100,000    10,000,000          7,100,000    10,000,000                                7,100,000    10,000,000
Variable Cost (50% of Sales) (TVC)                                3,550,000      5,000,000          3,550,000      5,000,000                                3,550,000      5,000,000
Contribution (S - TVC)                                3,550,000      5,000,000          3,550,000      5,000,000                                3,550,000      5,000,000
Contribution Margin Ration                                               50                    50                        50                    50                                               50                    50
Fixed Cost (FC)                                2,410,000      2,410,000          2,410,000      2,410,000                                2,410,000      2,410,000
EBIT (S-TVC-FC)                                1,140,000      2,590,000          1,140,000      2,590,000                                1,140,000      2,590,000
Interest                                    823,000          823,000              420,000          420,000 606000          606,000
(420000+(3100000*13%)) (420000+(1550000*12%))
EBT                                    317,000      1,767,000              720,000      2,170,000                                    534,000      1,984,000
Tax (40%)                                    126,800          706,800              288,000          868,000                                    213,600          793,600
EAT (A)                                    190,200      1,060,200              432,000      1,302,000                                    320,400      1,190,400
Shares of common stock (B)                                    310,000          310,000 465000 465000 372000 372000
(310000+(3100000/20)) (310000+(1550000/25))
EPS (A/B)                                           0.61                 3.42                     0.93                 2.80                                           0.86                 3.20

Related Solutions

Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 6,600,000 Variable costs (50% of sales) 3,300,000 Fixed costs 1,960,000 Earnings before interest and taxes (EBIT) $ 1,340,000 Interest (10% cost) 520,000 Earnings before taxes (EBT) $ 820,000 Tax (35%) 287,000 Earnings after taxes (EAT) $ 533,000 Shares of common stock 360,000 Earnings per share $ 1.48 The company is currently financed with 50 percent debt and 50 percent equity (common...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 7,500,000 Variable costs (50% of sales) 3,750,000 Fixed costs 2,050,000 Earnings before interest and taxes (EBIT) $ 1,700,000 Interest (10% cost) 700,000 Earnings before taxes (EBT) $ 1,000,000 Tax (35%) 350,000 Earnings after taxes (EAT) $ 650,000 Shares of common stock 450,000 Earnings per share $ 1.44 The company is currently financed with 50 percent debt and 50 percent equity (common...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 6,100,000 Variable costs (50% of sales) 3,050,000 Fixed costs 1,910,000 Earnings before interest and taxes (EBIT) $ 1,140,000 Interest (10% cost) 420,000 Earnings before taxes (EBT) $ 720,000 Tax (40%) 288,000 Earnings after taxes (EAT) $ 432,000 Shares of common stock 310,000 Earnings per share $ 1.39 The company is currently financed with 50 percent debt and 50 percent equity (common...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 5,700,000 Variable costs (50% of sales) 2,850,000 Fixed costs 1,870,000 Earnings before interest and taxes (EBIT) $ 980,000 Interest (10% cost) 340,000 Earnings before taxes (EBT) $ 640,000 Tax (35%) 224,000 Earnings after taxes (EAT) $ 416,000 Shares of common stock 270,000 Earnings per share $ 1.54 The company is currently financed with 50 percent debt and 50 percent equity (common...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 5,500,000 Variable costs (50% of sales) 2,750,000 Fixed costs 1,850,000 Earnings before interest and taxes (EBIT) $ 900,000 Interest (10% cost) 300,000 Earnings before taxes (EBT) $ 600,000 Tax (40%) 240,000 Earnings after taxes (EAT) $ 360,000 Shares of common stock 250,000 Earnings per share $ 1.44 The company is currently financed with 50 percent debt and 50 percent equity (common...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 6,400,000 Variable costs (50% of sales) 3,200,000 Fixed costs 1,940,000 Earnings before interest and taxes (EBIT) $ 1,260,000 Interest (10% cost) 480,000 Earnings before taxes (EBT) $ 780,000 Tax (40%) 312,000 Earnings after taxes (EAT) $ 468,000 Shares of common stock 340,000 Earnings per share $ 1.38 The company is currently financed with 50 percent debt and 50 percent equity (common...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 6,500,000 Variable costs (50% of sales) 3,250,000 Fixed costs 1,950,000 Earnings before interest and taxes (EBIT) $ 1,300,000 Interest (10% cost) 500,000 Earnings before taxes (EBT) $ 800,000 Tax (30%) 240,000 Earnings after taxes (EAT) $ 560,000 Shares of common stock 350,000 Earnings per share $ 1.60 The company is currently financed with 50 percent debt and 50 percent equity (common...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 5,300,000 Variable costs (50% of sales) 2,650,000 Fixed costs 1,830,000 Earnings before interest and taxes (EBIT) $ 820,000 Interest (10% cost) 260,000 Earnings before taxes (EBT) $ 560,000 Tax (30%) 168,000 Earnings after taxes (EAT) $ 392,000 Shares of common stock 230,000 Earnings per share $ 1.70 The company is currently financed with 50 percent debt and 50 percent equity (common...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as...
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 6,800,000 Variable costs (50% of sales) 3,400,000 Fixed costs 1,980,000 Earnings before interest and taxes (EBIT) $ 1,420,000 Interest (10% cost) 560,000 Earnings before taxes (EBT) $ 860,000 Tax (30%) 258,000 Earnings after taxes (EAT) $ 602,000 Shares of common stock 380,000 Earnings per share $ 1.58 The company is currently financed with 50 percent debt and 50 percent equity (common...
DELSING CANNING COMPANY IS CONSIDERING AN EXPANSION OF ITS FACILITIES. ITS CURRENT INCOME STATEMENT IS AS...
DELSING CANNING COMPANY IS CONSIDERING AN EXPANSION OF ITS FACILITIES. ITS CURRENT INCOME STATEMENT IS AS FOLLOWS: SALES............................................................................ 7,100,100 VARIABLE COSTS (50% OF SALES).............................3,550,000 FIXED COSTS.................................................................2,010,000 EBIT.................................................................................1,540,000 INTEREST (10% COST)....................................................620,000 EBT.....................................................................................920,000 TAX (30%)..........................................................................276,000 EAT.....................................................................................644,000 SHARES COMMON STOCK..............................................410,000 EPS...........................................................................................1.57 The company is currently financed with 50% debt and 50% equity (common stock, par value of $10). In order to expand the facilities, Mr. Delsing estimates a need for $4.1 million in additional financing. His investment banker has laid out three plans...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT