Question

Aant Investments Inc. currently has $3.5 million in debt outstanding, bearing in interest rate of 12.3%. It wishes to finance a $5 million expansion program and is considering five alternatives. Plan Debt 0% 35% 50% Preferred Equity 0% 100% 0% 65% 0% 50% 20% 30% 20% 20% 50% 60% so The preferred stock dividend will be 12% and the price of common stock will be $18 per share. The company currently has 750,000 shares of common stock outstanding and is in 40% tax bracket. a. If the earnings before interest and taxes are $1.5 million, what would be earning per share for five alternatives, assuming no immediate increase in the operating profit. b. Compute the degree of financial leverage (DFL) for each alternatives at the expected EBIT level of $1.5 million C. Which alternative do you prefer and why?

Answer 1

Assumption

1) Rate of interest is same for the new project expansion through debt i.e 12.3%

Solution

We will first take the given data.

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Then we will solve the questions

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We got the solution for (a) and (b)

(c) Definitely we will select Plan 1 as it has higher EPS showing greater profitability and it has lowest Degree of financial leverage which shows the volatility of earning with respect to expansion by issuing debt. It is a favorable situation for the company having good EPS with Low Degree of financial leverage.