15. The Lopez-Portillo Company has $11.8 million in assets, 80 percent financed
ID: 2648656 • Letter: 1
Question
15. The Lopez-Portillo Company has $11.8 million in assets, 80 percent financed by debt, and 20 percent financed by common stock. The interest rate on the debt is 14 percent and the par value of the stock is $10 per share. President Lopez-Portillo is considering two financing plans for an expansion to $24 million in assets.
Under Plan A, the debt-to-total-assets ratio will be maintained, but new debt will cost a whopping 17 percent! Under Plan B, only new common stock at $10 per share will be issued. The tax rate is 40 percent.
a.
If EBIT is 15 percent on total assets, compute earnings per share (EPS) before the expansion and under the two alternatives. (Round your answers to 2 decimal places.)
Earnings Per Share
Current
$
Plan A
$
Plan B
$
b.
What is the degree of financial leverage under each of the three plans? (Round your answers to 2 decimal places.)
Degree Of
Financial Leverage
Current
Plan A
Plan B
c.
If stock could be sold at $20 per share due to increased expectations for the firm
a.
If EBIT is 15 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
Current Plan A Plan B Asset $11.8 m $24 m $24 M Debt 80% stock 20% interest rate on debt 14% 17% per value of share $10 per share $10 per share number of share 11.88*.2/10 0.236 24*.20/10 0.48 24/10 2.4 Note 1. Debt to total assets shoulb be maintained in plan A, therefore 80 % shall be considered in debt 2. In Plan B, only share shall issued, therefore no debt is there A. Calculation of EPS Current Plan A Plan B EBIT (15% of total asset) 1.77 3.6 3.6 Less : Interest 11.8*80%*14% 1.3216 24*80%*17% 3.264 Earning before tax 0.4484 0.336 3.6 less :tax@40% 0.17936 0.1344 1.44 Earning after tax/amount 0.26904 0.2016 2.16 availabe to shareholders Divided by number of share 0.236 0.48 2.4 Earning per share 1.14 0.42 0.9 B. Degree of financial leverage = EBIT/EBT EBIT 1.77 3.6 3.6 EBT 0.4484 0.336 3.6 FINANCIAL LEVERAGE 3.95 10.71 1 Current Plan A Plan B Asset $11.8 m $24 m $24 M Debt 80% stock 20% interest rate on debt 14% 17% per value of share $20 per share $20per share number of share 11.88*.2/20 0.118 24*.20/20 0.24 24/20 1.2 A. Calculation of EPS Current Plan A Plan B EBIT (15% of total asset) 1.77 3.6 3.6 Less : Interest 11.8*80%*14% 1.3216 24*80%*17% 3.264 Earning before tax 0.4484 0.336 3.6 less :tax@40% 0.17936 0.1344 1.44 Earning after tax/amount 0.26904 0.2016 2.16 availabe to shareholders Divided by number of share 0.118 0.24 1.2 Earning per share 2.28 0.84 1.8
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