The Lopez-Portillo Company has $12.3 million in assets, 70 percent financed by d

Question

The Lopez-Portillo Company has $12.3 million in assets, 70 percent financed by debt, and 30 percent financed by common stock. The interest rate on the debt is 8 percent and the par value of the stock is $10 per share. President Lopez-Portillo is considering two financing plans for an expansion to $26.5 million in assets. Under Plan A, the debt-to-total-assets ratio will be maintained, but new debt will cost a whopping 11 percent! Under Plan B, only new common stock at $10 per share will be issued. The tax rate is 35 percent.

If EBIT is 9 percent on total assets, compute earnings per share (EPS) before the expansion and under the two alternatives. (Round your answers to 2 decimal places.)

What is the degree of financial leverage under each of the three plans? (Round your answers to 2 decimal places.)

If stock could be sold at $20 per share due to increased expectations for the firm

If EBIT is 9 percent on total assets, compute earnings per share (EPS) before the expansion and under the two alternatives. (Round your answers to 2 decimal places.)

Explanation / Answer

EBIT = 9%*12300000 =$1107000

Interest = 8%*(70%*12300000) = $688800

Net Income = (1107000-688800)*(1-35%) =$271830

Number of shares outstanding = (30%*12300000)/10

=369000 shares

EPS = 271830/369000

=$0.74 per share

Under Plan A:

EBIT = 9%*(12300000+26500000) =$3492000

Interest = 11%*(70%*38800000) = $2987600

Net Income = (3492000-2987600)*(1-35%) =$327860

Number of shares outstanding = (30%*38800000)/10

=1164000 shares

EPS = 327860/1164000

=$0.28 per share

Under Plan B:

EBIT = 9%*(12300000+26500000) =$3492000

Interest = 8%*(70%*12300000) = $6888000

Net Income = (3492000-688800)*(1-35%) =$1822080

Number of shares outstanding = ((30%*12300000)+26500000)/10

=3019000 shares

EPS = 1822080/3019000

=$0.60 per share

b. degree of financial leverage:

Current = EBIT/(EBIT-Interest)

=1107000/(1107000-688800)

=2.647

Under Plan A = 3492000/(3492000-2987600)

=6.923

Under Plan B = 3492000/(3492000-6888000)

=01.028

c. Under Plan A:

Number of shares outstanding = (30%*38800000)/20

=582000

EPS = 327860/582000

=$0.56 per share

Under Plan B:

Number of shares outstanding = ((30%*12300000)+26500000)/20

=1509500 shares

EPS = 1822080/1509500

=$1.20 per share

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.