Delsing Canning Company is considering an expansion of its facilities. Its curre
ID: 2403527 • Letter: D
Question
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales Variable costs (50% of sales) Fixed costs Earnings before interest and taxes (EBIT) Interest (10% cost) Earnings before taxes (EBT) Tax (35%) Earnings after taxes (EAT) Shares of common stock Earnings per share S 6,900,000 3,450,000 1,990,000 1,460,000 580,000 880,000 308,000 S 572,000 390,000 1.47 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 $3.9 million in additional financing. His investment banker has laid out three plans for him to consider: 1. Sell $3.9 million of debt at 9 percent. 2. Sell $3.9 million of common stock at $25 per share. 3. Sell $1.95 million of debt at 8 percent and $1.95 million of common stock at $30 per share Variable costs are expected to stay at 50 percent of sales, while fixed expenses will increase to $2,490,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1.95 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 expansionExplanation / Answer
Break-Even Point
Before expansion
3980000
After expansion
4980000
WORKING NOTE : BEFORE EXPANSION
Break-Even point = fixed cost / profit volume ratio = 1990000/ 50% = 3980000
WORKING NOTE : AFTER EXPANSION
Break-Even point = fixed cost / profit volume ratio = 2490000 / 50% = 4980000
PROFIT VOLUME RATIO = CONTRIBUTION / SALES
Where contribution = sales - variable cost
DEGREE OF OPERATING LEVERAGE
Before expansion
2.36
After expansion
2.71
WORKING NOTE : BEFORE EXPANSION
Degree of operating leverage = contribution / EBIT = 3450000 / 1460000 = 2.36
WORKING NOTE : AFTER EXPANSION
Degree of operating leverage = contribution / EBIT = 3950000 / 1460000 = 2.71
DEGREE OF FINANCIAL LEVERAGE
Before expansion
1.66
WORKING NOTE : BEFORE EXPANSION
Degree of financial leverage = EBIT / EBT = 1460000 / 880000 = 1.66
After expansion
DEGREE OF FINANCIAL LEVERAGE
100% DEBT
2.76
100% EQUITY
1.66
50% DEBT & 50% EQUITY
2.02
WORKING NOTE : AFTER EXPANSION
100% DEBT
100% EQUITY
50% DEBT & 50% EQUITY
EBIT
1460000
1460000
1460000
EBT
529000
880000
724000
DEGREE OF FINANCIAL LEVERAGE
2.76
1.66
2.02
WORKING NOTE FOR EBIT AND EBT IF SALES IS 7.9 MILLIONS
100% DEBT
100% EQUITY
50% DEBT & 50% EQUITY
Sales
7900000
7900000
7900000
Variable cost @50%
3950000
3950000
3950000
Fixed cost
2490000
2490000
2490000
EBIT
1460000
1460000
1460000
Interest
931000
580000
736000
EBT
529000
880000
724000
Tax @35%
185150
308000
253400
EAT
343850
572000
470600
Shares of common stock
390000
780000
585000
Earnings per share
0.88
0.73
0.8
WORKING NOTE FOR EBIT AND EBT IF SALES IS 10.8 MILLIONS
100% DEBT
100% EQUITY
50% DEBT & 50% EQUITY
Sales
10800000
10800000
10800000
Variable cost @50%
5400000
5400000
5400000
Fixed cost
2490000
2490000
2490000
EBIT
2910000
2910000
2910000
Interest
931000
580000
736000
EBT
1979000
2330000
2174000
Tax @35%
692650
815500
760900
EAT
1286350
1514500
1413100
Shares of common stock
390000
780000
585000
Earnings per share
3.2
1.94
2.41
Earnings per share
First year
Last year
100% DEBT
0.88
3.2
100% EQUITY
0.73
1.94
50% DEBT & 50% EQUITY
0.8
2.41
Break-Even Point
Before expansion
3980000
After expansion
4980000
WORKING NOTE : BEFORE EXPANSION
Break-Even point = fixed cost / profit volume ratio = 1990000/ 50% = 3980000
WORKING NOTE : AFTER EXPANSION
Break-Even point = fixed cost / profit volume ratio = 2490000 / 50% = 4980000
PROFIT VOLUME RATIO = CONTRIBUTION / SALES
Where contribution = sales - variable cost
DEGREE OF OPERATING LEVERAGE
Before expansion
2.36
After expansion
2.71
WORKING NOTE : BEFORE EXPANSION
Degree of operating leverage = contribution / EBIT = 3450000 / 1460000 = 2.36
WORKING NOTE : AFTER EXPANSION
Degree of operating leverage = contribution / EBIT = 3950000 / 1460000 = 2.71
DEGREE OF FINANCIAL LEVERAGE
Before expansion
1.66
WORKING NOTE : BEFORE EXPANSION
Degree of financial leverage = EBIT / EBT = 1460000 / 880000 = 1.66
After expansion
DEGREE OF FINANCIAL LEVERAGE
100% DEBT
2.76
100% EQUITY
1.66
50% DEBT & 50% EQUITY
2.02
WORKING NOTE : AFTER EXPANSION
100% DEBT
100% EQUITY
50% DEBT & 50% EQUITY
EBIT
1460000
1460000
1460000
EBT
529000
880000
724000
DEGREE OF FINANCIAL LEVERAGE
2.76
1.66
2.02
WORKING NOTE FOR EBIT AND EBT IF SALES IS 7.9 MILLIONS
100% DEBT
100% EQUITY
50% DEBT & 50% EQUITY
Sales
7900000
7900000
7900000
Variable cost @50%
3950000
3950000
3950000
Fixed cost
2490000
2490000
2490000
EBIT
1460000
1460000
1460000
Interest
931000
580000
736000
EBT
529000
880000
724000
Tax @35%
185150
308000
253400
EAT
343850
572000
470600
Shares of common stock
390000
780000
585000
Earnings per share
0.88
0.73
0.8
WORKING NOTE FOR EBIT AND EBT IF SALES IS 10.8 MILLIONS
100% DEBT
100% EQUITY
50% DEBT & 50% EQUITY
Sales
10800000
10800000
10800000
Variable cost @50%
5400000
5400000
5400000
Fixed cost
2490000
2490000
2490000
EBIT
2910000
2910000
2910000
Interest
931000
580000
736000
EBT
1979000
2330000
2174000
Tax @35%
692650
815500
760900
EAT
1286350
1514500
1413100
Shares of common stock
390000
780000
585000
Earnings per share
3.2
1.94
2.41
Earnings per share
First year
Last year
100% DEBT
0.88
3.2
100% EQUITY
0.73
1.94
50% DEBT & 50% EQUITY
0.8
2.41
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