Edsel Research Labs has $30.20 million in assets. Currently, half of these asset
ID: 2424026 • Letter: E
Question
Edsel Research Labs has $30.20 million in assets. Currently, half of these assets are financed with long-term debt at 7 percent and half with common stock having a par value of $10. Ms. Edsel, the Vice-President of Finance, wishes to analyze two refinancing plans, one with more debt (D) and one with more equity (E). The company earns a return on assets before interest and taxes of 9 percent. The tax rate is 35 percent. Under Plan D, a $7.55 million long-term bond would be sold at an interest rate of 10 percent and 755,000 shares of stock would be purchased in the market at $10 per share and retired. Under Plan E, 755,000 shares of stock would be sold at $10 per share and the $7,550,000 in proceeds would be used to reduce long-term debt.
How would each of these plans affect earnings per share? Consider the current plan and the two new plans. (Negative amounts should be indicated by a minus sign. Leave no cells blank - be certain to enter "0" wherever required. Round your answers to 2 decimal places.)
Which plan(s) would produce the highest EPS? Note that due to tax loss carry-forwards and carry-backs, taxes can be a negative number.
Assuming return on assets is back to the original 9 percent, but the interest rate on new debt in Plan D is 6 percent, which of the three plans will produce the highest EPS?
a-1.How would each of these plans affect earnings per share? Consider the current plan and the two new plans. (Negative amounts should be indicated by a minus sign. Leave no cells blank - be certain to enter "0" wherever required. Round your answers to 2 decimal places.)
Explanation / Answer
a-1)
a-2) Higher EPS: Plan D $0.78
Plan E $0.63
Current & E $ 1.345
Current and Plan E together have highest EPS.
b) If return on assets become 10%, then after tax increase in net income is $0.1963 M
So, EPS at Current Plan = 0.715 + 0.13 = 0.84
Plan D = 0.78 + 0.26 = 1.04
Plan E = 0.63 + 0.087 = 0.72
c) If the new debt contains interest rate 6%, then EPS in Plan - D = 2.718 - 1.510 - 0.4228 = 0.7852 / 0.755 = 1.04 and others remain the same.
Plan D = 1.04
The plans Current and E = 1.345
Plan E = 0.63
The Plan Current and D = 1.755
Particulars Current Plan Plan D Plan E Amount of Debt 15.1 M 22.65 7.55 Amount of Equity 15.1 M (1.51 shares) 7.55 (0.755 shares) 22.65 (2.265 shares) Return on assets 2.718 M 2.718 M 2.718 M Less: Interest 1.057 1.812 0.5285 1.661 0.9060 2.1895 Less: tax 0.58135 0.3171 0.766325 Income after tax 1.07965 0.5889 1.423175 EPS $0.715 0.78 0.63Related Questions
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