The levels of assets, liabilities, stockholders\' equity, and operating income h
ID: 2481962 • Letter: T
Question
The levels of assets, liabilities, stockholders' equity, and operating income have been stable in recent years; however, Cook Corporation is planning a $1,800,000 expansion program that will increase income from operations by $350,000 to $1,550,000. Cook is planning to sell 8.5% notes at par to finance the expansion.
Required:
Round your answers to the nearest cent.
1. What earnings per share does Cook report before the expansion? EPS = Net Income/Average Common Shares Outstanding
$ per share
2. What earnings per share will Cook report if the proposed expansion is undertaken?
$per share Would this use of leverage be advantageous to Cook's stockholders? (yes/no)
Select Yes No
3. Suppose income from operations will increase by only $150,000. Would this use of leverage be advantageous to Cook's stockholders? (yes/no)
4. Suppose that income from operations will increase by $200,000 and that Cook could also raise the required $1,800,000 by issuing an additional 100,000 shares of common stock (assume the additional shares were outstanding for the entire year). Which means of financing would stockholders prefer? (debt/equity)
Explanation / Answer
(1) EPS before expansion = $770,000 / 300,000 = $2.57
(2) YES
After expansion:
Additional Interest expense on bonds = $1,800,000 x 8.5% = $153,000
Income before tax = $1,550,000 - $100,000 - $153,000 = $1,297,000
Net income = $1,297,000 x (1 - 0.3) = $1,297,000 x 0.7 = $907,900
EPS = $907,900 / 300,000 = $3.03
Since EPS will increase, it will be advantageous.
(3) NO
Income before tax = $(1,200,000 + 150,000 - 100,000 - 153,000) = $1,097,000
Net income = $1,097,000 x 0.7 = $767,900
EPS = $767,900 / 300,000 = $2.56
Since EPS slightly falls, this is not advantageous.
Note: First 3 questions are answered.
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