The Norman Automatic mailer Machine Company is planning to expand production. The expansion will cost $2000,000, which can either be financed by bonds at an interest rate of 12 percent or by selling 40,000 shares of common stock at $50 per share. The current income statement before expansion is as follows:
Norman Automatic Mailer
Income Statement
Sales $3000,000
Variable Costs (40%) 1,200,000
Contribution margin 1,800,000
Fixed Costs 800,000
earnings before interest and taxes 1000,000
interest expense 400,000
Earnings beofre tax 600,000
taxes @ 34% 204,000
earnings after tax $396,000
Shares 100,000
earnings per share $3.96
After the expansion sales are expected to increase by 1,500,000. Variable Costs will remain at 40 percent of sales, and fixed costs will increase to $550,000. The tax rate is 34 percent.
a) construct the income statement for the two financial plans.
b) calculate the degree of operating leverage, the degree of financial leverage, and the degree of combined leverage, after expansion for the two financing plans
c) calculate the ebit/eps indifference point.
d) explain which plan you favor and the risks involved.
formulas: DOL= CM/EBIT
DFL=EBIT/EBT
DCL= DOL * DFL
indifference point= (S(B) * I(A)- S(A) * I(B) / S(B) - S(A)
I is interet costs under plan A and B
S is shares Outstanding under plan A and B
1 answer
1 answer