Edsel Research Labs has $27 million in assets. Currently, half of these assets a

Question

Edsel Research Labs has $27 million in assets. Currently, half of these assets are financed with long-term debt at 5 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 5 percent. The tax rate is 30 percent. Under Plan D, a $6.75 million long-term bond would be sold at an interest rate of 11 percent and 675,000 shares of stock would be purchased in the market at $10 per share and retired. Under Plan E, 675,000 shares of stock would be sold at $10 per share and the $6,750,000 in proceeds would be used to reduce long-term debt. 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 "O" wherever required. Round your answers to 2 decimal places.) s Per Share Current Plan D Plan E a-2. Which plan(s) would produce the highest EPS? Note that due to tax loss carry-forwards and carry backs, tax es can be a negative number Current Plan and Plan E Current Plan and Plan D O Plan D O Plan E

Explanation / Answer

Calculation EPS for current Plane:

    Return on Assets (ROA) is 5%.

         ROA            = EBIT/Total assets

         5%               =EBIT/27,000,000

          EBIT           =0.05*27,000,000

                             =$1,350,000

      

     EBIT                 =$1,350,000

     Less: Interests          675000

     EBT                  = $675,000

     Less: Taxes        =     202500

     Earnings available to shareholders   $472500  

     Here 13.5 million is equity and each is issued at par value of $10.

     Therefore No of Shareholders      = $13,500,000/10

                                                          =1350000

     EPS                     = Earnings available to Shareholders/No of shareholders

                                =$472500/1350000

                                =$0.35

                             

      Current plan EPS is $ 0.35

       

      Calculation of EPS in Plane D:

      EBIT                  = $1,350,000

      Less: Interest       =      148500

      EBT                   = $1201500

      Less: Taxes         = $360450    

      Earnings available to shareholders $ 8,41050

      No of shareholders are  600,000

               EPS         = $841050,/600,000

                              =    $1.40

      Calculation of EPS in Plane E:

      EBIT                  =$1,350,000

      Less: Proceeds            675,000

       EBT                  =    $675000

      Less: Taxes         =   202500

      

      Earnings available to shareholders    472500

                  EPS         = $472500/6765, 000

                                   = $ 0.7

        2a. Plan D

       b.Current plan and E

        c. Plan D

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