Delsing Canning Company is considering an expansion of its facilities. Its curre
ID: 2615430 • Letter: D
Question
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 6,100,000 Variable costs (50% of sales) 3,050,000 Fixed costs 1,910,000 Earnings before interest and taxes (EBIT) $ 1,140,000 Interest (10% cost) 420,000 Earnings before taxes (EBT) $ 720,000 Tax (40%) 288,000 Earnings after taxes (EAT) $ 432,000 Shares of common stock 310,000 Earnings per share $ 1.39 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 $3.1 million in additional financing. His investment banker has laid out three plans for him to consider: Sell $3.1 million of debt at 13 percent. Sell $3.1 million of common stock at $20 per share. Sell $1.55 million of debt at 12 percent and $1.55 million of common stock at $25 per share. Variable costs are expected to stay at 50 percent of sales, while fixed expenses will increase to $2,410,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1.55 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.) b. The degree of operating leverage before and after expansion. Assume sales of $6.1 million before expansion and $7.1 million after expansion. Use the formula: DOL = (S ? TVC) / (S ? TVC ? FC). (Round your answers to 2 decimal places.) c-1. The degree of financial leverage before expansion. (Round your answers to 2 decimal places.) c-2. The degree of financial leverage for all three methods after expansion. Assume sales of $7.1 million for this question. (Round your answers to 2 decimal places.) d. Compute EPS under all three methods of financing the expansion at $7.1 million in sales (first year) and $10.0 million in sales (last year). (Round your answers to 2 decimal places.)
Explanation / Answer
a Existing After Expansion Sales 6,100,000 7,650,000 Variable Cost (50% of Sales) 3,050,000 3,825,000 Contribution 3,050,000 3,825,000 Contribution Margin Ration 50 50 Fixed Cost 1,910,000 2,410,000 EBIT 1,140,000 1,415,000 Interest (10% cost) 420,000 EBT 720,000 Tax (40%) 288,000 EAT 432,000 Shares of common stock 310,000 EPS 1.39 Break Even point in dollars Fixed Cost / Contribution margin Ratio = 1910000/50% 2410000/50% = 3,820,000 4,820,000 b Existing After Expansion Sales (S) 6,100,000 7,100,000 Variable Cost (50% of Sales) (TVC) 3,050,000 3,550,000 Contribution (S - TVC) 3,050,000 3,550,000 Contribution Margin Ration 50 50 Fixed Cost (FC) 1,910,000 2,410,000 EBIT (S-TVC-FC) 1,140,000 1,140,000 DOL= (S-TVC)/(S-TVC-FC) DOL= 3050000/1140000 3550000/1140000 DOL= 2.68 3.11 c-1 Existing Sales (S) 6,100,000 Variable Cost (50% of Sales) (TVC) 3,050,000 Contribution (S - TVC) 3,050,000 Contribution Margin Ration 50 Fixed Cost (FC) 1,910,000 EBIT (S-TVC-FC) 1,140,000 Interest (10% cost) 420,000 EBT 720,000 DFL= EBIT /EBT = 1140000/720000 = 1.58 c-2 Method 1 Method 2 Method 3 100% debt 100% equity 50% Equity 50% Debt Sales (S) 7,100,000 7,100,000 7,100,000 Variable Cost (50% of Sales) (TVC) 3,550,000 3,550,000 3,550,000 Contribution (S - TVC) 3,550,000 3,550,000 3,550,000 Contribution Margin Ration 50 50 50 Fixed Cost (FC) 2,410,000 2,410,000 2,410,000 EBIT (S-TVC-FC) 1,140,000 1,140,000 1,140,000 Interest 823,000 420,000 606000 (420000+(3100000*13%)) (420000+(1550000*12%)) EBT 317,000 720,000 534,000 DFL= EBIT /EBT = 1140000/317000 1140000/720000 1140000/534000 = 3.60 1.58 2.13 d. Method 1 Method 2 Method 3 100% debt 100% equity 50% Equity 50% Debt 1st year last year 1st year last year 1st year last year Sales (S) 7,100,000 10,000,000 7,100,000 10,000,000 7,100,000 10,000,000 Variable Cost (50% of Sales) (TVC) 3,550,000 5,000,000 3,550,000 5,000,000 3,550,000 5,000,000 Contribution (S - TVC) 3,550,000 5,000,000 3,550,000 5,000,000 3,550,000 5,000,000 Contribution Margin Ration 50 50 50 50 50 50 Fixed Cost (FC) 2,410,000 2,410,000 2,410,000 2,410,000 2,410,000 2,410,000 EBIT (S-TVC-FC) 1,140,000 2,590,000 1,140,000 2,590,000 1,140,000 2,590,000 Interest 823,000 823,000 420,000 420,000 606000 606,000 (420000+(3100000*13%)) (420000+(1550000*12%)) EBT 317,000 1,767,000 720,000 2,170,000 534,000 1,984,000 Tax (40%) 126,800 706,800 288,000 868,000 213,600 793,600 EAT (A) 190,200 1,060,200 432,000 1,302,000 320,400 1,190,400 Shares of common stock (B) 310,000 310,000 465000 465000 372000 372000 (310000+(3100000/20)) (310000+(1550000/25)) EPS (A/B) 0.61 3.42 0.93 2.80 0.86 3.20
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