In: Finance
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:
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 = (S −
TVC) / (S − TVC − 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 ______________________________
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 |