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
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 $

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yahayadanjuma55 yahayadanjuma55 · Answer 1 · 2020-06-03T04:06:38+02:00

Answer:

Explanation:

Current Plan A Plan B

EBIT 1.243 2.365 2.365

Interest 1.017 1.935 1.017

EBT 0.226 0.43 1.348

Tax (30%) 0.0678 0.129 0.4044

Net Income 0.1582 0.301 0.9436

EPS $ 1.40 $ 1.40 $ 0.83

No. of shares 0.113 0.215 1.133

DFL 5.50 5.50 1.75

In the current plan, Debt = 90% x 11.3 = 10.17m

Interest expense = 10% x 10.17 = 1.017m

No. of shares = Equity / Par value = 11.3 x 10% / 10 = 0.113m

EBIT = 11% x 11.3 = 1.243m

EPS = Net Income / No. of shares = 0.1582m / 0.113m = $1.40

In Plan A, Debt = 90% x 21.5 = 19.35m

Interest expense = 10% x 19.35 = 1.935m

No. of shares = Equity / Par value = 21.5 x 10% / 10 = 0.215m

EBIT = 11% x 21.5 = 2.365m

EPS = Net Income / No. of shares = 0.301m / 0.215m = $1.40

In Plan B, Debt = 90% x 11.3 = 10.17m

Interest expense = 10% x 10.17 = 1.017m

No. of shares = Equity / Par value = (21.5 - 10.17) / 10 = 1.133m

EBIT = 11% x 21.5 = 2.365m

EPS = Net Income / No. of shares = 0.9436m / 1.133m = $0.83

DFL = EBIT / EBT