Question

Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as follows:
I have everything but D.

Sales	$	6,200,000
Variable costs (50% of sales)		3,100,000
Fixed costs		1,920,000
Earnings before interest and taxes (EBIT)	$	1,180,000
Interest (10% cost)		440,000
Earnings before taxes (EBT)	$	740,000
Tax (30%)		222,000
Earnings after taxes (EAT)	$	518,000
Shares of common stock		320,000
Earnings per share	$	1.62

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. Delsing estimates a need for $3.2 million in additional financing. His investment banker has laid out three plans for him to consider:

1. Sell $3.2 million of debt at 14 percent.
2. Sell $3.2 million of common stock at $20 per share.
3. Sell $1.60 million of debt at 13 percent and $1.60 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 $2,420,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1.60 million per year for the next five years.
Delsing 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 dollars not in millions, i.e, $1,234,567.)
  Before Expansion:

After Expansion:

b. The degree of operating leverage before and after expansion. Assume sales of $6.2 million before expansion and $7.2 million after expansion. Use the formula: DOL = (S − TVC) / (S − TVC − FC). (Round your answers to 2 decimal places.)
  

Before Expansion:

After Expansion:

c-1. The degree of financial leverage before expansion. (Round your answers to 2 decimal places.)
  

Degree of financial leverage:


c-2. The degree of financial leverage for all three methods after expansion. Assume sales of $7.2 million for this question. (Round your answers to 2 decimal places.)
  

100% Debt:

100% Equity:

50% Debit 50% Equity:

d. Compute EPS under all three methods of financing the expansion at $7.2 million in sales (first year) and $10.1 million in sales (last year). (Round your answers to 2 decimal places.)
  

100% Debt:

100% Equity:

50% Debt 50% Equity:

Answer 1

First we calculate earning before interest and tax at given estimated sales $7.2 millions and $10.1 millions

Three plans of expansion

PLAN:-I Issue $3.2 million of debt@14%

PLAN:-II Issue $3.2 million at 20 per share

PLAN:-III Issue $1.6 million of debt @ 13% and $1.6 million at 25 per share

And then calculate Earing per share at each type of EBIT.

calculations are given below