Question

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 earns 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 Earnings 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.)

b-2. Which plan would be most favorable if return on assets fell to 5.05 percent? Consider the current plan and the two new plans.

• Current Plan

• Plan E

• Plan D

b-3. Compute the earnings per share if return on assets increased to 15.1 percent. (Round your answers to 2 decimal places.)

b-4. Which plan would be most favorable if return on assets increased to 15.1 percent? Consider the current plan and the two new plans.

• Plan D

• Plan E

• Current Plan

c-1. If the market price for common stock rose to $10 before the restructuring, compute the earnings per share. Continue to assume that $3,005,000 million in debt will be used to retire stock in Plan D and $3,005,000 million of new equity will be sold to retire debt in Plan E. Also assume that return on assets is 10.1 percent. (Round your answers to 2 decimal places.)

c-2. If the market price for common stock rose to $10 before the restructuring, which plan would then be most attractive?

• Plan E

• Plan D

• Current Plan

Answer 1

Current plan Plan D Plan E $ 1,214,020.00$ 1,214,020.00 $ 1,214,020.00 $ 607,010.00 $ 970,615.00 $ $ 607,010.00 $ 243,405.00 $ $ 242,804.00 $ $ 364,206.00o $ 146,043.00 $ EBIT Less: Interest Profit before tax 303,505.00 910,515.00 Less: Tax 40% 97,362.00 $ 364,206.00 Net income Number of shares EPS 546,309.00 751,250 375,625 1,126,875 0.48 $ 0.39 $ 0.48 Current plan Plan D Plan E 607,010.00 $ 607,010.00 $ 607,010.00 $ 970,615.00 $ $ (363,605.00) $ $ (145,442.00) $ EBIT 607,010.00 Less: Interest Profit before tax 303,505.00 303,505.00 Less: Tax 40% 121,402.00 Net income Number of shares $ (218,163.00) $ 182,103.00 751,250 375,625 1,126,875 (0.58) $ EPS 0.16 Current plan Plan D Plan E $ 1,815,020.00 $ 1,815,020.00 $ 1,815,020.00 $ 607,010.00 $ $ 1,208,010.00 $ $ 483,204.00 $ 724,806.00 $ EBIT 970,615.00 $ 844,405.00 $ 1,511,515.00 337,762.00 $ 506,643.00 $ 906,909.00 Less: Interest 303,505.00 Profit before tax Less: Tax 40% Net income Number of shares 604,606.00 751,250 375,625 1,126,875 0.96 $ 1.35 $ EPS 0.80 Current plan Plan D Plan E $ 1,214,020.00 $ 1,214,020.00 $ 1,214,020.00 364,206.00 $ EBIT 146,043.00 $ EAT 546,309.00 Number of shares 751,250 450,750 1,051,750 0.48 $ 0.32 $ 0.52 EPS

Current plan Plan D Plan E 0.48 $ 0.39 $ 0.48 a) Earnings per share Current plan Plan D Plan E $ (0.58) $ 0.16 b-1) Earnings per share b-2) Plan E Current plan Plan D Plan E 0.96 $ 1.35 $ 0.80 b-3) Earnings per share b-4) Plan D Current plan Plan D Plan E 0.48 $ 0.32 $ 0.52 c-1) Earnings per share c-2) Plan E %24 %24

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