Question

Bangla Communications Corporation (BCC) supplies headphones to airlines for use with movie and stereo programs. The headphones sell for Tk. 288 per set, and this year's sales are expected to be 45,000 units. V ariable production costs for the expected sales under present production methods are estimated at T k, 10,200,000 and fixed production (operating) costs at present are T k. 1,560,000. BCC has T k, 4,800,000 of debt outstanding at an interest rate of eight percent. There are 240,000 shares of common stock outstanding, and there is no preferred stock. The dividend payout ratio is 70 , and BCC is in the 40 % marginal tax bracket.

The company is considering investing Tk. 7.200,000 in new equipment. Sales would not increase, but variable costs per unit would decline by 20%. Also, fixed operating costs would increase from Tk. 1,560,000 to Tk. 1.800.000. BCC would raise the required capital by borrowing Tk. 7,200,000 at ten percent interest or by selling 240,000 additional shares at Tk. 30 per share. 

a) What would be the BCC's EPS (i) under the old production process, (ii) under the new production process if it uses debt, and (ii) under the new process if it uses common stock? 

b) Calculate the DOL, DFL and DTL under the existing setup and under the new setup with each type of financing. 

c) On the basis of the analysis in part b, which plan is the riskiest? Why?

Answer 1