Question

Not found Q 50 Do Dickinson Company has $12,020,000 million in assets. Currently half of these assets are financed with long-term debt at 10.1 percent and half with common stock having a par value of $8. Ms. Smith, Vice President of Finance, wishes to analyze two refinancing plans, one with more debt (D) and one with more equity (E). The company eams a return on assets before interest and taxes of 10.1 percent. The tax rate is 40 percent. Tax loss carryover provisions apply, so negative tax amounts are permissable. Under Plan D, a $3,005,000 million long-term bond would be sold at an interest rate of 12.1 percent and 375,625 shares of stock would be purchased in the market at $8 per share and retired. Under Plan E, 375,625 shares of stock would be sold at $8 per share and the $3,005,000 in proceeds would be used to reduce long-term debt. a. How would each of these plans affect earnings per share? Consider the current plan and the two new plans. (Round your answers to 2 decimal places.) Current Plan Plan D Plan E Eamings per share b-1. Compute the earnings per share if return on assets fell to 5.05 percent. (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.) Current Plan Plan D Plan E Eamings per share b-2. Which plan would be most favorable if return on assets fell to 5.05 percent? Consider the F3 FS F7 8 2 4

Answer 1

(a)

The Total Assets = $12,020,000

Thus, Total Debt (50% of Total Assets) = $6,010,000

Total Equity (50% of Total Assets) = $6,010,000

ROA (Return of Assets) = 10.10%

ROA = EBIT/Total Assets

Thus, EBIT = Total Assets*ROA

EBIT = $12,020,000*10.10%

EBIT = $1,214,020.00

Particulars	Amount in $
EBIT	$1,214,020.00
Less: Interest (Total Debt*10.10%)	($607,010.00)
EBT	$607,010.00
Less: Tax (40%)	($242,804.00)
EAT	$364,206.00
No. of Equity Shares (Total Equity/$8)	741,250
EPS	$0.48

PLAN D

New bonds issued = $3,005,000.00 @12.10%

Total Interest = $607,010 + ($3,005,000*12.10%)

Stocks Repurchases = 375,625

New No. of Equity shares = 375,625 (741,250-375,625)

Particulars	Amount in $
EBIT	$1,214,020.00
Less: Interest (Total Debt*10.10%)	($970,615.00)
EBT	$243,405.00
Less: Tax (40%)	($97,362.00)
EAT	$144,043.00
No. of Equity Shares (Total Equity/$8)	375,625
EPS	$0.39

PLAN E

Stocks Sold = 375625 ($3,005,000.00 worth)

Bonds Repurchased = $3,005,000.00

New No. of Equity shares = 375,625 (741,250-375,625)

Total Interest = $3,005,000*10.10%

Particulars	Amount in $
EBIT	$1,214,020.00
Less: Interest (Total Debt*10.10%)	($303,505.00)
EBT	$910,515.00
Less: Tax (40%)	($364,206.00)
EAT	$546,309.00
No. of Equity Shares (Total Equity/$8)	375,625
EPS	$1.45

(b-1)

If ROA falls to 5.05%, the EBIT would be affected.

The new EBIT = $12,020,000*5.05%

New EBIT = $607,010.00

Current Plan -

Particulars	Amount in $
EBIT	$607,010.00
Less: Interest (Total Debt*10.10%)	($607,010.00)
EBT	NIL
Less: Tax (40%)	NIL
EAT	NIL
No. of Equity Shares (Total Equity/$8)	741,250
EPS	NIL

PLAN D

All the working shall remain the same, except for the EBIT amount.

Particulars	Amount in $
EBIT	$607,010.00
Less: Interest (Total Debt*10.10%)	($970,615.00)
EBT	($363,605.00)
Less: Tax (40%)	($145,442.00)
EAT	($218,163.00)
No. of Equity Shares (Total Equity/$8)	375,625
EPS	($0.58)

PLAN E

In Plan E too, all the working shall remain the same, except for the EBIT amount.

Particulars	Amount in $
EBIT	$607,010.00
Less: Interest (Total Debt*10.10%)	($303,505.00)
EBT	$303,505.00
Less: Tax (40%)	($121,402.00)
EAT	$182,103.00
No. of Equity Shares (Total Equity/$8)	375,625
EPS	$0.48

(b-2)

Plan D - Because as seen in b-1, it maximises EPS at an ROA of 5.05%

(b-3)

If ROA increases to 15.1%, only the EBIT would be affected.

The new EBIT = $12,020,000*15.1%

New EBIT = $607,010.00

Current Plan

Particulars	Amount in $
EBIT	$1,815,020.00
Less: Interest (Total Debt*10.10%)	($607,010.00)
EBT	$1,208,010.00
Less: Tax (40%)	($483,204.00)
EAT	$724,806.00
No. of Equity Shares (Total Equity/$8)	741,250
EPS	$0.96

PLAN D

All the working shall remain the same, except for the EBIT amount.

Particulars	Amount in $
EBIT	$1,815,020.00
Less: Interest (Total Debt*10.10%)	($970,615.00)
EBT	$844,405.00
Less: Tax (40%)	($337,762.00)
EAT	$506,643.00
No. of Equity Shares (Total Equity/$8)	375,625
EPS	$1.35

PLAN E

In Plan E too, all the working shall remain the same, except for the EBIT amount.

Particulars	Amount in $
EBIT	$1,815,020.00
Less: Interest (Total Debt*10.10%)	($303,505.00)
EBT	$15,11,515.00
Less: Tax (40%)	($604,606.00)
EAT	$906,909.00
No. of Equity Shares (Total Equity/$8)	375,625
EPS	$2.41

(b-4)

Plan E - Because as seen in b-3, it maximises EPS at an ROA of 15.1%.

(c-1)

Current Plan

The difference in this shall be the number of equity shares, as they will decrease (Share price increased to $10)

Particulars	Amount in $
EBIT	$1,214,020.00
Less: Interest (Total Debt*10.10%)	($607,010.00)
EBT	$607,010.00
Less: Tax (40%)	($242,804.00)
EAT	$364,206.00
No. of Equity Shares (Total Equity/$10)	601,000
EPS	$0.61

PLAN D

New bonds issued = $3,005,000.00 @12.10%

Total Interest = $607,010 + ($3,005,000*12.10%)

Stocks Repurchases = 300,500

New No. of Equity shares = 300,500 (741,250-300,500)

Particulars	Amount in $
EBIT	$1,214,020.00
Less: Interest (Total Debt*10.10%)	($970,615.00)
EBT	$243,405.00
Less: Tax (40%)	($97,362.00)
EAT	$144,043.00
No. of Equity Shares (Total Equity/$8)	300,500
EPS	$0.49

PLAN E

Stocks Sold = 300,500 ($3,005,000.00 worth)

Bonds Repurchased = $3,005,000.00

New No. of Equity shares = 300,500 (741,250-300,500)

Total Interest = $3,005,000*10.10%

Particulars	Amount in $
EBIT	$1,214,020.00
Less: Interest (Total Debt*10.10%)	($303,505.00)
EBT	$910,515.00
Less: Tax (40%)	($364,206.00)
EAT	$546,309.00
No. of Equity Shares (Total Equity/$8)	300,500
EPS	$1.82

(c-2)

Plan E - Because as seen in c-1, it maximises EPS when stock price rises to $10.