BREAKEVEN AND LEVERAGE

Wingler Communications Corporation (WCC) produces premium stereoheadphones that sell for $28.60 per set, and this year's sales areexpected to be 450,000 units. Variable production costs for theexpected sales under present production methods are estimated at$10,500,000, and fixed production (operating) costs at present are$1,560,000. WCC has $4,800,000 of debt outstanding at an interestrate of 8%. There are 240,000 shares of common stock outstanding,and there is no preferred stock. The dividend payout ratio is 70%,and WCC is in the 40% federal-plus-state tax bracket.

The company is considering investing $7,200,000 in newequipment. Sales would not increase, but variable costs per unitwould decline by 20%. Also, fixed operating costs would increasefrom $1,560,000 to $1,800,000. WCC could raise the required capitalby borrowing $7,200,000 at 10% or by selling 240,000 additionalshares of common stock at $30 per share.

1. What would be WCC's EPS (1) under the old production process,(2) under the new process if it uses debt, and (3) under the newprocess if it uses common stock? Do not round intermediatecalculations. Round your answers to the nearest cent.
   1.  $
   2.  $
   3.  $
2. 
   
3. At what unit sales level would WCC have the same EPS assumingit undertakes the investment and finances it with debt or withstock? {Hint: V = variable cost per unit = $8,400,000/450,000, andEPS = [(PQ - VQ - F - I)(1 - T)]/N. Set EPS_Stock =EPS_Debt and solve for Q.} Do not round intermediatecalculations. Round your answer to the nearest whole.
     units
4. 
   
5. At what unit sales level would EPS = 0 under the threeproduction/financing setups - that is, under the old plan, the newplan with debt financing, and the new plan with stock financing?(Hint: Note that V_Old = $10,500,000/450,000, and use thehints for part b, setting the EPS equation equal to zero.) Do notround intermediate calculations. Round your answers to the nearestwhole.
   Old plan    units
   New plan with debt financing    units
   New plan with stock financing    units
6. 
   
7. On the basis of the analysis in parts a through c, and giventhat operating leverage is lower under the new setup, which plan isthe riskiest, which has the highest expected EPS, and which wouldyou recommend? Assume here that there is a fairly high probabilityof sales falling as low as 250,000 units, and determineEPS_Debt and EPS_Stock at that sales level tohelp assess the riskiness of the two financing plans. Do not roundintermediate calculations. Round your answers to two decimalplaces. Negative amount should be indicated by a minus sign.
   EPS_Debt = $
   EPS_Stock = $