Phelps Canning Company is considering an expansion of its facilities

Subject:FinancePrice: Bought3

Share With

Phelps Canning Company is considering an expansion of its facilities. Its current income statement is as follows:

 Sales $5,500,000   Less: Variable expense (50% of sales) 2,750,000   Fixed expense 1,850,000     Earnings before interest and taxes (EBIT) 900,000   Interest (10% cost) 300,000     Earnings before taxes (EBT) 600,000   Tax (40%) 240,000     Earnings after taxes (EAT) $360,000     Shares of common stock 250,000   EPS $1.44 

Phelps Canning Company is currently financed with 50 percent debt and 50 percent equity (common stock). To expand facilities, Mr. Phelps estimates a need for $2.5 million in additional financing. His investment dealer has laid out three plans for him to consider:

 

1. Sell $2.5 million of debt at 13 percent.
2. Sell $2.5 million of common stock at $20 per share.
3. Sell $1.25 million of debt at 12 percent and $1.25 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 $2,350,000 per year. Mr. Phelps is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1.25 million per year for the next five years.

Mr. Phelps 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 the answers in dollars not in millions.)

 Break-even point  Before expansion$        After expansion$      

b. The DOL before and after expansion. Assume sales of $5.5 million before expansion and $6.5 million after expansion. (Round the final answers to 2 decimal places.)

 DOL  Before expansion X   After expansion X 

c-1. The DFL before expansion at sales of $5.5 million. (Round the final answers to 2 decimal places.)

DFL           X

c-2. The DFL for all three methods after expansion. Assume sales of $6.5 million. (Round the final answers to 2 decimal places.)

 DFL  100% Debt X   100% Equity X   50% Debt & 50% Equity X 

d. Compute EPS under all three methods of financing the expansion at $6.5 million in sales (first year) and $10.5 million in sales (last year). (Round the final answers to 2 decimal places.)

EPSFirst yearLast year  100% Debt$   $     100% Equity      50% Debt & 50% Equity    

e. Not available in Connect.