Question

Dickinson Company has $12,120,000 million in assets. Currently half of these assets are financed with long-term debt at 10.6 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 10.6 percent. The tax rate is 45 percent. Tax loss carryover provisions apply, so negative tax amounts are permissable.

Under Plan D, a $3,030,000 million long-term bond would be sold at an interest rate of 12.6 percent and 378,750 shares of stock would be purchased in the market at $8 per share and retired.

Under Plan E, 378,750 shares of stock would be sold at $8 per share and the $3,030,000 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 5.30 percent. (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.)
Current Plan, Plan D, Plan E

Earnings per share ______, _____, _____.

        

b-2. Which plan would be most favorable if return on assets fell to 5.30 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 15.6 percent. (Round your answers to 2 decimal places.)
Current Plan, Plan D, Plan E

Earnings per share ____, _______, ______.

b-4. Which plan would be most favorable if return on assets increased to 15.6 percent? Consider the current plan and the two new plans.

	Plan E
	Plan D
	Current Plan

c-1. If the market price for common stock rose to $12 before the restructuring, compute the earnings per share. Continue to assume that $3,030,000 million in debt will be used to retire stock in Plan D and $3,030,000 million of new equity will be sold to retire debt in Plan E. Also assume that return on assets is 10.6 percent. (Round your answers to 2 decimal places.)

Current Plan, Plan D, Plan E

Earnings per share ______, _______, ______

         

c-2. If the market price for common stock rose to $12 before the restructuring, which plan would then be most attractive?
  

	Plan E
	Plan D
	Current Plan

Answer 1

	Current Plan	Plan D	Plan E
EBIT	1,284,720	1,284,720	1,284,720
Less: Interest	642,360	1,024,140	321180
Earnings before tax	642,360	260,580	963,540
Less: Tax @45%	289,062	117,261	433,593
Net Income	353,298	143,319	529,947
Number of shares	757,500	378,750	1,136,250
EPS	0.4664	0.3784	0.4664

b-1
	Current Plan	Plan D	Plan E
EBIT	642,360	642,360	642,360
Less: Interest	642,360	1,024,140	321180
Earnings before tax	0	-381,780	321,180
Less: Tax @45%	0	-171,801	144,531
Net Income	0	-209,979	176,649
Number of shares	757,500	378,750	1,136,250
EPS	0	-0.5544	0.155467
Plan E since highest EPS

b-3
	Current Plan	Plan D	Plan E
EBIT	1,890,720	1,890,720	1,890,720
Less: Interest	642,360	1,024,140	321180
Earnings before tax	1,248,360	866,580	1,569,540
Less: Tax @45%	561,762	389,961	706,293
Net Income	686,598	476,619	863,247
Number of shares	757,500	378,750	1,136,250
EPS	0.9064	1.2584	0.759733
Plan D

c-1
	Current Plan	Plan D	Plan E
EBIT	1,284,720	1,284,720	1,284,720
Less: Interest	642,360	1,024,140	321180
Earnings before tax	642,360	260,580	963,540
Less: Tax @45%	289,062	117,261	433,593
Net Income	353,298	143,319	529,947
Number of shares	757,500	505,000	1,010,000
EPS	0.4664	0.2838	0.5247
Plan E