Question

Daising Canning Company is considering an expansion of its facilities. Its current income statement is as follows: Sales $ 5,200,000 Variable costs (50% of sales) 2.600.000 Fored costs 1.820,000 Eamings before interest and taxes (EBIT) $ 780,000 Interest (10% costi 240.000 Eamings before taxes (EBT) $540,000 Tax (40%) 216.000 Eamings after taxes (EAT) $ 324,000 Shares of common stock 220,000 Eamings per share 1.47 The company is currently financed with 50 percent debt and 50 percent equity (common stock, par value of $10). In order to expand the facilities, Mr. Daising estimates a need for $2 2 million in additional financing. His investment banker has laid out three plans for him to consider 1. 2. 3. Sell $2.2 million of debt at 10 percent Sell $2 2 million of common stock at $20 per share. Sell $1.10 million of debt at 9 percent and $1.10 million of common stock at $25 per share Variable costs are expected to stay at 50 percent of sales, while fixed expenses will increase to $2,320,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1 million per vear for the next five years Dalsing is interested in a thorough analysis of his expansion plans and methods of financing. He would like you to analyze the following a. The break-even point for operating expenses before and after expansion in sales dollars). (Enter your answers in dollare not in millions, is, $1,234,567.) Break-Even Point Before expansion After expansion b. The degree of operating leverage before and after expansion. Assume sales of $5.2 milion before expansion and $6.2 milion after expansion. Use the formula: DOL(S-TVC)/(S-TVC - FC). (Round your answers to 2 decimal places.) Degree of Operating Leverage Before expansion After expansion 0-1. The degree of financial leverage before expansion (Round your answer to 2 decimal places.) Degree of financial leverage 0-2. The degree of financial leverage for all three methods after expansion. Assume sales of $6.2 million for this question (Round your answers to 2 decimal places.) Degree of Financial Lavenge 100 E d. Compute EPS under all three methods of financing the expansion at 56.2 million in sales (first year) and $10.2 million in sales (last year). (Round your answers to 2 decimal places.) Earnings per Share First War Last War 100% SA Det & SE

Answer 1

a).

Formula for Break-even points in Dollars: Total Fixed Cost/Contribution margin Ratio

- Break-even before expansion:-

Total Fixed Cost= $ 1820000

Contribution margin Ratio = 50% (given in question)

Break-even before expansion= 1820000/50%

= $ 3640,000

- Break-even after expansion:-

Total Fixed Cost= $ 2320000

Contribution margin Ratio = 50% (given in question)

Break-even before expansion= 2320000/50%

= $ 4640,000

b).

Formula for Degree of Operating Leverage(DOL): (Sales- Total variable Cost)/(Sales- Total variable Cost-Fixed Cost)

- DOL before Expansion

DOL= (5200,000-2600,000)/(5200,000-2600,000-1820,000)

= 2600,000/780,000

= 3.33 times

- DOL after Expansion

DOL= (6200,000-3100,000)/(6200,000-3100,000-2320,000)

= 3100,000/780,000

= 3.97 times

C-1). Formula for Degree of financial Leverage(DFL): EBIT/EBT

- DFT before Expansion= 780000/540000

= 1.44 times

Computing Income Statement after expansion under all 3 different option: (Amt in $)

Particular	100% Debt @ 10%	100% Equity	50% Equity-50% debt @ 9%
Sales	6200,000	6200,000	6200,000
Less: variable Cost (50%)	(3100,000)	(3100,000)	(3100,000)
Less: Fixed Cost	(2320,000)	(2320,000)	(2320,000)
Earning before Interest & Tax (EBIT)	780,000	780,000	780,000
Less: Interest @10 %	(240,000)	(240,000)	(240,000)
Less; Interest @ 10%/9% (Note-1)	(220,000)	00	(99,000)
Earning before Tax (EBT)	320,000	540,000	441,000
Less: Tax @ 40%	(128,000)	(216,000)	(176,400)
Earning after Tax	192,000	324,000	264,600
No. of Shares(Common Stock) (Note-2)	220,000	330,000	264,000
Earning per Share	0.87	0.98	1

Note 1- 2.2 million debt in 100% debt option @ 10%. Interest is 2.2 million*10%= 0.22 million

1.1 million debt in 50-50(Equity-Debt) portion @ 9%. Interest is 1.1 million*9%= 99,000

Note 2- 100% equity option will have increase in no. of common stock which is 2.2 million of $20 per share = 110,000. So, after Expansion total no. of common stock = 220,000+110,000

50% equity option will have increase in no. of common stock which is 1.1 million of $25 per share = 44,000. So, after Expansion total no. of common stock = 220,000+44,000

C-2). Formula for Degree of financial Leverage(DFL): EBIT/EBT

- DFT after Expansion

For 100% Debt Option = 780000/320000

= 2.44 times

For 100% Equity Option = 780000/540000

= 1.44 times

For 50% Debt-50% Equity Option = 780000/441000

= 1.77 times

Computing Income Statement after expansion under all 3 different option for last year ( sales is 10.2 million): (Amt in $)

Particular	100% Debt @ 10% Interest rate	100% Equity	50% Equity-50% debt @ 9% Interest rate
Sales	10200,000	10200,000	10200,000
Less: variable Cost (50%)	(5100,000)	(5100,000)	(5100,000)
Less: Fixed Cost	(2320,000)	(2320,000)	(2320,000)
Earning before Interest & Tax (EBIT)	2780,000	2780,000	2780,000
Less: Interest @10 %	(240,000)	(240,000)	(240,000)
Less; Interest @ 10%/9% (Note-1)	(220,000)	00	(99,000)
Earning before Tax (EBT)	2320,000	2540,000	2441,000
Less: Tax @ 40%	(928,000)	(1016,000)	(976,400)
Earning after Tax	1392,000	1524,000	1464,600
No. of Shares(Common Stock) (Note-2)	220,000	330,000	264,000
Earning per Share	6.32	4.62	5.54

Note 1- 2.2 million debt in 100% debt option @ 10%. Interest is 2.2 million*10%= 0.22 million

1.1 million debt in 50-50(Equity-Debt) portion @ 9%. Interest is 1.1 million*9%= 99,000

Note 2- 100% equity option will have increase in no. of common stock which is 2.2 million of $20 per share = 110,000. So, after Expansion total no. of common stock = 220,000+110,000

50% equity option will have increase in no. of common stock which is 1.1 million of $25 per share = 44,000. So, after Expansion total no. of common stock = 220,000+44,000

D).

Computation of EPS under all 3 financing after expansion at 6.2 million in sales (1st Year) and 10.2 million in sales (2nd year)

Particular	100% Debt @ 10% Interest rate	100% Equity	50% Equity-50% debt @ 9% Interest rate
First Year	0.87	0.98	1
Last Year	6.32	4.62	5.54

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