BUSI320 FINANCE

7. The Manning Company has financial statements as shown next, which are representative of the company’s historical average.

   The firm is expecting a 35 percent increase in sales next year, and management is concerned about the company’s need for external funds. The increase in sales is expected to be carried out without any expansion of fixed assets, but rather through more efficient asset utilization in the existing store. Among liabilities, only current liabilities vary directly with sales.

Income Statement

  Sales

$

220,000  

  Expenses

171,200  

  Earnings before interest and taxes

$

48,800  

  Interest

8,300  

  Earnings before taxes

$

40,500  

  Taxes

16,300  

  Earnings after taxes

$

24,200  

  Dividends

$

7,260  

Balance Sheet

Assets

Liabilities and Stockholders' Equity

  Cash

$

8,000  

  Accounts payable

$

23,400  

  Accounts receivable

33,000  

  Accrued wages

1,850  

  Inventory

69,000  

  Accrued taxes

3,350  

   Current assets

$

110,000  

    Current liabilities

$

28,600  

  Fixed assets

93,000  

  Notes payable

8,300  

  Long-term debt

21,500  

  Common stock

117,000  

  Retained earnings

27,600  

  Total assets

$

203,000  

  Total liabilities and     stockholders' equity

$

203,000  

   Using the percent-of-sales method, determine whether the company has external financing needs, or a surplus of funds. (Hint: A profit margin and payout ratio must be found from the income statement.) (Do not round intermediate calculations. Input the amount as a positive value.)

  The firm  $  in .

10. Healthy Foods Inc. sells 50-pound bags of grapes to the military for $25 a bag. The fixed costs of this operation are $130,000, while the variable costs of grapes are $.20 per pound.

a.

What is the break-even point in bags? (Round your answer to 2 decimal places.)

  Break-even point

 bags 

b.

Calculate the profit or loss (EBIT) on 12,000 bags and on 34,000 bags. (Input all amounts as positive values. Round your answers to the nearest whole number.)

Bags

Profit/Loss

Amount

12,000     

$   

34,000     

$   

c.

What is the degree of operating leverage at 30,000 bags and at 34,000 bags? (Round your answers to 2 decimal places.)

Bags

Degree of Operating Leverage

30,000       

34,000       

d.

If Healthy Foods has an annual interest expense of $11,000, calculate the degree of financial leverage at both 30,000 and 34,000 bags. (Round your answers to 2 decimal places.)

Bags

Degree of Financial Leverage

30,000       

34,000       

e.

What is the degree of combined leverage at both 30,000 and 34,000 bags? (Round your answers to 2 decimal places.)

Bags

Degree of Combined Leverage

30,000       

34,000       

12. Lenow’s Drug Stores and Hall’s Pharmaceuticals are competitors in the discount drug chain store business. The separate capital structures for Lenow and Hall are presented next.

Lenow

Hall

  Debt @ 10%

$

230,000  

Debt @ 10%

$

460,000  

  Common stock, $10 par

460,000  

Common stock, $10 par

230,000  

    Total

$

690,000  

   Total

$

690,000  

  Common shares

46,000  

Common shares

23,000  

a.

Complete the following table given earnings before interest and taxes of $27,000, $69,000, and $71,000. Assume the tax rate is 30 percent. (Leave no cells blank - be certain to enter "0" wherever required. Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.)

EBIT

Total assets

EBIT/TA

   Lenow EPS

  Hall EPS

What is the relationship between the EPS

 of the two firms?

$  27,000  

$690,000  

 %  

$    

$    

$  69,000  

$690,000  

 %  

$    

$    

$71,000  

$690,000  

 %  

$    

$    

b-1.

What is the EBIT/TA rate when the firm's have equal EPS?

 EBIT/TA rate

 %  

b-2.

What is the cost of debt?

  Cost of debt

 %  

b-3.

State the relationship between earnings per share and the level of EBIT.

EPS is unaffected by financial leverage when the pre-tax return on assets (EBIT/TA)  the cost of debt.

c.

If the cost of debt went up to 12 percent and all other factors remained equal, what would be the break-even level for EBIT?

  Break-even level

$   

14. Dickinson Company has $11,840,000 million in assets. Currently half of these assets are financed with long-term debt at 9.2 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 9.2 percent. The tax rate is 45 percent. Tax loss carryover provisions apply, so negative tax amounts are permissable.

     Under Plan D, a $2,960,000 million long-term bond would be sold at an interest rate of 11.2 percent and 370,000 shares of stock would be purchased in the market at $8 per share and retired.

     Under Plan E, 370,000 shares of stock would be sold at $8 per share and the $2,960,000 in proceedswould 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 4.60 percent. (Leave no cells blank - be certain to enter "0" wherever required. 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 4.60 percent? Consider the current plan and the two new plans.

b-3.

Compute the earnings per share if return on assets increased to 14.2 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 14.2 percent? Consider the current plan and the two new plans.

c-1.

If the market price for common stock rose to $10 before the restructuring, compute the earnings per share. Continue to assume that $2,960,000 million in debt will be used to retire stock in Plan D and $2,960,000 million of new equity will be sold to retire debt in Plan E. Also assume that return on assets is 9.2 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 $10 before the restructuring, which plan would then be most attractive?

15. The Lopez-Portillo Company has $11.3 million in assets, 90 percent financed by debt, and 10 percent financed by common stock. The interest rate on the debt is 10 percent and the par value of the stock is $10 per share. President Lopez-Portillo is considering two financing plans for an expansion to $21.5 million in assets. Under Plan A, the debt-to-total-assets ratio will be maintained, but new debt will cost a whopping 10 percent! Under Plan B, only new common stock at $10 per share will be issued. The tax rate is 30 percent.

a.

If EBIT is 11 percent on total assets, compute earnings per share (EPS) before the expansion and under the two alternatives. (Round your answers to 2 decimal places.)

Earnings Per Share

  Current

$   

  Plan A

$   

  Plan B

$   

b.

What is the degree of financial leverage under each of the three plans? (Round your answers to 2 decimal places.)

Degree Of Financial Leverage

  Current

  Plan A

  Plan B

c.

If stock could be sold at $20 per share due to increased expectations for the firm’s sales and earnings, what impact would this have on earnings per share for the two expansion alternatives? Compute earnings per share for each. (Round your answers to 2 decimal places.)

Earnings Per Share

  Plan A

$   

  Plan B

$   

The Lopez-Portillo Company has $11.3 million in assets, 90 percent financed by debt, and 10 percent financed by common stock. The interest rate on the debt is 10 percent and the par value of the stock is $10 per share. President Lopez-Portillo is considering two financing plans for an expansion to $21.5 million in assets. Under Plan A, the debt-to-total-assets ratio will be maintained, but new debt will cost a whopping 10 percent! Under Plan B, only new common stock at $10 per share will be issued. The tax rate is 30 percent.

a.

If EBIT is 11 percent on total assets, compute earnings per share (EPS) before the expansion and under the two alternatives. (Round your answers to 2 decimal places.)

Earnings Per Share

  Current

$   

  Plan A

$   

  Plan B

$   

b.

What is the degree of financial leverage under each of the three plans? (Round your answers to 2 decimal places.)

Degree Of Financial Leverage

  Current

  Plan A

  Plan B

c.

If stock could be sold at $20 per share due to increased expectations for the firm’s sales and earnings, what impact would this have on earnings per share for the two expansion alternatives? Compute earnings per share for each. (Round your answers to 2 decimal places.)

Earnings Per Share

  Plan A

$   

  Plan B

$   

Delsing 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  

  Fixed costs

1,820,000  

  Earnings before interest and taxes (EBIT)

$

780,000  

  Interest (10% cost)

240,000  

  Earnings before taxes (EBT)

$

540,000  

  Tax (40%)

216,000  

  Earnings after taxes (EAT)

$

324,000  

  Shares of common stock

220,000  

  Earnings 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. Delsing estimates a need for $2.2 million in additional financing. His investment banker has laid out three plans for him to consider:

1.Sell $2.2 million of debt at 10 percent.

2.Sell $2.2 million of common stock at $20 per share.

3.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 $1.10 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.)

Break-Even Point

  Before expansion

  $   

  After expansion

 $   

b.

The degree of operating leverage before and after expansion. Assume sales of $5.2 million before expansion and $6.2 million 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

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 $6.2 million for this question. (Round your answers to 2 decimal places.)

Degree of Financial Leverage

  100% Debt

  100% Equity

  50% Debt & 50% Equity

d.

Compute EPS under all three methods of financing the expansion at $6.2 million in sales (first year) and $10.2 million in sales (last year).(Round your answers to 2 decimal places.)

Earnings per share

First year

Last year

  100% Debt

$   

$   

  100% Equity

  50% Debt & 50% Equity

Sinclair Manufacturing and Boswell Brothers Inc. are both involved in the production of brick for the homebuilding industry. Their financial information is as follows:

Sinclair

Boswell

  Capital Structure

  Debt @ 10%

$

840,000   

0   

  Common stock, $10 per share

560,000   

$

1,400,000   

    Total

$

1,400,000   

$

1,400,000   

  Common shares

56,000   

140,000   

  Operating Plan:

  Sales (54,000 units at $15 each)

$

810,000   

$

810,000   

  Variable costs

648,000   

324,000   

  Fixed costs

0   

304,000   

  Earnings before interest and taxes (EBIT)

$

162,000   

$

182,000   

The variable costs for Sinclair are $12 per unit compared to $6 per unit for Boswell.

a.

If you combine Sinclair’s capital structure with Boswell’s operating plan, what is the degree of combined leverage? (Round your answer to 2 decimal places.)

  Degree of combined leverage

b.

If you combine Boswell’s capital structure with Sinclair’s operating plan, what is the degree of combined leverage? (Round your answer to the nearest whole number.)

  Degree of combined leverage

c.

In part b, if sales double, by what percentage will EPS increase? (Round your answer to the nearest whole percent.)

  EPS will increase by

 %