DELSING CANNING COMPANY IS CONSIDERING AN EXPANSION OF ITSFACILITIES. ITS CURRENT INCOME STATEMENT IS AS FOLLOWS:
SALES............................................................................7,100,100
VARIABLE COSTS (50% OFSALES).............................3,550,000
FIXEDCOSTS.................................................................2,010,000
EBIT.................................................................................1,540,000
INTEREST (10%COST)....................................................620,000
EBT.....................................................................................920,000
TAX(30%)..........................................................................276,000
EAT.....................................................................................644,000
SHARES COMMONSTOCK..............................................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 thefacilities, Mr. Delsing estimates a need for $4.1 million inadditional financing. His investment banker has laid out threeplans for him to consider:
1) Sell $4.1 million of debt at 11%
2) Sell $4.1 million of common stock at $20 per share
3) Sell $2.05 million of debt at 10% and $2.05 million of commonstock at $25 per share.
Variable costs are expected to stay at 50% of sales, while fixedexpenses will increase to $2,510,000 per year. Delsing is not surehow much this expansion will add to sales, but he estimates saleswill rise by $2.05 million per year for the next 5 years.
Delsing is interested in a thorough analysis of his expansionplans and methods of financing. He would like you to analyze thefollowing:
a. The break-even point for operating expenses beforeand after expansion (in sales dollars). ENTER YOUR ANSWERS INDOLLARS NOT IN MILLIONS, I.E. $1,234,567.
| BREAK-EVEN POINT |
| BEFORE EXPANSION | |
| AFTER EXPANSION | |
b. The degree of operating leverage before and afterexpansion. Assume sales of $7.1 million before expansion, and $8.1million after expansion. Use the formula
DOL = (S - TVC) / (S - TVC - FC). ROUND YOUR ANSWERS TO 2DECIMAL PLACES.
| DEGREE OF OPERATING LEVERAGE |
| BEFORE EXPANSION | |
| AFTER EXPANSION | |
c. The degree of financial leverage before expansion.ROUND YOUR ANSWERS TO 2 DECIMAL PLACES.
d. The degree of financial leverage for all threemethods after expansion. Assume sales of $8.1 million for thisquestion. ROUND YOUR ANSWERS TO 2 DECIMAL PLACES.
| DEGREE OF FINANCIAL LEVERAGE |
| 100 % DEBT | |
| 100% EQUITY | |
| 50% DEBT & 50% EQUITY | |
e. Compute EPS under all three methods of financing theexpansion at $8.1 million in sales (first year) and $11.0 millionin sales (last year). ROUND ANSWERS TO 2 DECIMALPLACES.
| EPS |
| FIRST YEAR | LAST YEAR |
| 100% DEBT | | |
| 100% EQUITY | | |
| 50% DEBT & 50% EQUITY | | |
