a.
To compute: Indifference points of EBIT and EPS.
a.
Explanation of Solution
Given information:
Tax rate: 40%
Average EBIT level: $6 million (per year)
Calculating EBIT-EPS indifference point:
Indifference can be seen, when debt financing EPS is considered equals to equity financing EPS,
Now,
Therefore, the indifference point will be seen when EBIT become $2.4million
b.
To compute: Earning per share for financial plan 1 and plan 2.
b.
Explanation of Solution
Calculating EPS for both financial plans:
Plan 1 ($) | Plan 2 ($) | |
EBIT | 6.0 | 6.0 |
Interest | 0.0 | 1.2 |
Earning before tax | 6.0 | 4.8 |
Tax@40% | 2.4 | 1.92 |
Earnings after tax | 3.6 | 2.88 |
Outstanding shares | 2.0 | 1.0 |
EPS | 1.80 | 2.88 |
Table (1)
Therefore, the earning per share for Plan 1 will be $1.80 and Plan 2 will be $2.88
c.
To determine: Factors for financial planning.
c.
Explanation of Solution
The factors for financial planning are as mentioned below:
- Capital structure, which is effectively followed by the parent company.
- Impact of financial plan on the financial status as well as stocks prices of the company.
- Probability distribution as per the expectation identified through EBIT.
d.
To determine: Suitable financial plan.
d.
Explanation of Solution
The plan 2 is must be recommended, because EPS (debt financing) is higher the EPS (equity financing).
e.
To compute: Earning per share when sales decreases by 5%.
e.
Explanation of Solution
Therefore, the time interest earned ratio will be 5 times.
f.
To compute: EBIT dropping level.
f.
Explanation of Solution
Therefore, the EBIT is supposed be drop by $1.8 (after deducting current EBIT from lower level). Along with that, it is required for the company to compliance with the agreement of loan.
g.
To compute: Probability of negative EPS.
g.
Explanation of Solution
Calculating earnings per share negative probability:
From Table V, the probability of a value greater than 2.0 standard deviations to the left of the mean is 2.28%, i.e. small.
Therefore, the probability of negative earning per share will be 2.28%.
Want to see more full solutions like this?
Chapter 14 Solutions
Bundle: Contemporary Financial Management, 14th + MindTap Finance, 1 term (6 months) Printed Access Card
- Quigley Inc. is considering two financial plans for the coming year. Management expects sales to be $300,000, operating costs to be $265,000, assets (which is equal to its total invested capital) to be $200,000, and its tax rate to be 35%. Under Plan A it would finance the firm using 25% debt and 75% common equity. The interest rate on the debt would be 8.8%, but under a contract with existing bondholders the TIE ratio would have to be maintained at or above 5.0. Under Plan B, the maximum debt that met the TIE constraint would be employed. Assuming that sales, operating costs, assets, total invested capital, the interest rate, and the tax rate would all remain constant, by how much would the ROE change in response to the change in the capital structure? Do not round your intermediate calculationsarrow_forwardSupa Inc. is considering plans A and B for financing their new Systems project of OMR 6 million. Plan A involves issuance of 250,000 shares of common stock at the current market price of OMR 2 per share. Plan B involves issuance of OMR 5 million, 8% bonds at face value. Income before interest and taxes on the new plant will be OMR2.5million. Income taxes are expected to be 20%. Supa, Inc. currently has 100,000 shares of common stock outstanding. Advice Supa Inc. as to which plan would be better and why? (The answer should show clear steps and calculations).arrow_forwardNCC Corporation is considering building a new facility in Texas. To raise money for the capital projects, the corporation plans the following capital structure: 40% of money will come from issuing bonds, and 60% will come from Retained Earnings or new common stock. The corporation does not currently have preferred stock. NCC Corporation will issue bonds with an interest rate of 9%, up to $30 million dollars in bonds. After issuing $30 million in bonds, the interest cost will rise to 12.5%. The next dividend on common stock is expected to be $2.00 per share. The stock price is $16.00 per share, and is expected to grow at 3% per year. The flotation cost for issuing new common stock is estimated at 12%. NCC Corporation has $66 million in retained earnings that can be used. The tax rate for NCC Corporation is 35%. What is the WACC after the second breakpoint? 12.55% 19.10% 13.57% 16.66% 15.3%arrow_forward
- NCC Corporation is considering building a new facility in Texas. To raise money for the capital projects, the corporation plans the following capital structure: 40% of money will come from issuing bonds, and 60% will come from Retained Earnings or new common stock. The corporation does not currently have preferred stock. NCC Corporation will issue bonds with an interest rate of 9%, up to $30 million dollars in bonds. After issuing $30 million in bonds, the interest cost will rise to 12.5%. The next dividend on common stock is expected to be $2.00 per share. The stock price is $16.00 per share, and is expected to grow at 3% per year. The flotation cost for issuing new common stock is estimated at 12%. NCC Corporation has $66 million in retained earnings that can be used. The tax rate for NCC Corporation is 35%.At what point does the second breakpoint occur? $50 million $75 million $125 million $100 million $110 millionarrow_forwardNCC Corporation is considering building a new facility in Texas. To raise money for the capital projects, the corporation plans the following capital structure: 40% of money will come from issuing bonds, and 60% will come from Retained Earnings or new common stock. The corporation does not currently have preferred stock. NCC Corporation will issue bonds with an interest rate of 9%, up to $30 million dollars in bonds. After issuing $30 million in bonds, the interest cost will rise to 12.5%. The next dividend on common stock is expected to be $2.00 per share. The stock price is $16.00 per share, and is expected to grow at 3% per year. The flotation cost for issuing new common stock is estimated at 12%. NCC Corporation has $66 million in retained earnings that can be used. The tax rate for NCC Corporation is 35%. What is the initial weighted average cost of capital (WACC) for NCC Corporation? 11.90% 11.77% 12.9% 15.3% 11.64%arrow_forwardNCC Corporation is considering building a new facility in Texas. To raise money for the capital projects, the corporation plans the following capital structure: 40% of money will come from issuing bonds, and 60% will come from Retained Earnings or new common stock. The corporation does not currently have preferred stock. NCC Corporation will issue bonds with an interest rate of 9%, up to $30 million dollars in bonds. After issuing $30 million in bonds, the interest cost will rise to 12.5%. The next dividend on common stock is expected to be $2.00 per share. The stock price is $16.00 per share, and is expected to grow at 3% per year. The flotation cost for issuing new common stock is estimated at 12%. NCC Corporation has $66 million in retained earnings that can be used. The tax rate for NCC Corporation is 35%. There are two breakpoints in NCC's capital structure. At what point does the first breakpoint occur? $75 million $100 million $110 million $125…arrow_forward
- Dubai Corporation manufactures construction equipment. It is currently at its target debt– equity ratio of .70. It’s considering building a new $45 million manufacturing facility. This new plant is expected to generate after-tax cash flows of $6.2 million a year in perpetuity. The company raises all equity from outside financing. There are three financing options: A new issue of common stock: The flotation costs of the new common stock would be 8 percent of the amount raised. The required return on the company’s new equity is 14 percent. A new issue of 20-year bonds: The flotation costs of the new bonds would be 4 percent of the proceeds. If the company issues these new bonds at an annual coupon rate of 8 percent, they will sell at par. Increased use of accounts payable financing: Because this financing is part of the company’s ongoing daily business, it has no flotation costs, and the company assigns it a cost that is the same as the overall firm WACC. Management has a target ratio…arrow_forwardA company is planning the financing of a major expansion. It will use common stock to fund this expansion. The company currently has 300,000 shares outstanding selling at an average of $130 per share. It would sell an additional 50,000 shares to bring in an estimated $5 million. The new project is expected to raise EBIT by 18% when implemented. The company’s capital structure contains long-term debt of $10 million which pays interest of 11%. Current Income Statement Net Sales 66,000,000 COGS 42,000,000 Gross Profits 24,000,000 S and A Expenses 9,300,000 Operating Profits 14,700,000 Interest on Debt 1,100,000 EBT 13,600,000 Taxes at 34% 4,600,000 EAT 9,000,000 Develop an analysis of EPS and show the effect of any dilution of earnings. Develop the same analysis for an alternative issue of $5 million of 10% preferred stock, and an alternative issue of $5 million of 9% debt. Develop specific comparative costs of all…arrow_forwardLandman Corporation (LC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of 64. It's considering building a new $65.4 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.93 million in perpetuity. There are three financing options: a. A new issue of common stock. The required return on the company's new equity is 15.4 percent. b. A new issue of 20-year bonds. If the company issues these new bonds at an annual coupon rate of 7.5 percent, they will sell at par. c. Increased use of accounts payable financing. Because this financing is part of the company's ongoing daily business, the company assigns it a cost that is the same as the overall firm WACC, Management has a target ratio of accounts payable to long-term debt of 12. (Assume there is no difference between the pretax and aftertax accounts payable cost.) If the tax rate is 24 percent, what is the NPV of the new plant? Note: A negative answer…arrow_forward
- The Ewing Distribution Company is planning a $240 million expansion of its chain of discount service stations to several neighboring states. This expansion will be financed, in part, with debt issued with a coupon interest rate of 16 percent. The bonds have a 15-year maturity and a $1,000 face value, and they will be sold to net Ewing $973 after issue costs. Ewing’s marginal tax rate is 40 percent.Preferred stock will cost Ewing 14 percent after taxes. Ewing’s common stock pays a dividend of $6 per share. The current market price per share is $18, and new shares can be sold to net $17 per share. Ewing’s dividends are expected to increase at an annual rate of 7 percent for the foreseeable future. Ewing expects to have $60 million of retained earnings available to finance the expansion.Ewing’s target capital structure is as follows: Debt 40 % Preferred stock 5 Common equity 55 Calculate the weighted cost of capital that is appropriate to use in evaluating this…arrow_forwardLandman Corporation (LC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .72. It's considering building a new $66.2 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.87 million in perpetuity. There are three financing options: a. A new issue of common stock. The required return on the company's new equity is 15.4 percent. b. A new issue of 20-year bonds: If the company issues these new bonds at an annual coupon rate of 7.1 percent, they will sell at par. c. Increased use of accounts payable financing: Because this financing is part of the company's ongoing daily business, the company assigns it a cost that is the same as the overall firm WACC. Management has a target ratio of accounts payable to long- term debt of .09. (Assume there is no difference between the pretax and aftertax accounts payable cost.) If the tax rate is 22 percent, what is the NPV of the new plant? Note: A negative…arrow_forwardPhotochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt-to-equity ratio of 0.56. It is considering building a new $62 million manufacturing facility. This new plant is expected to generate after-tax cash flows of $7.9 million a year in perpetuity. The company raises all equity from outside financing. The required financing will be met by the following: 1. A new issue of common stock. The flotation costs of the new common stock would be 9 percent of the amount raised. The required return on the company's new equity is 13 percent. 2. A new issue of 25-year bonds. The flotation costs of the new bonds would be 5 percent of the proceeds. If the company issues these new bonds at an annual coupon rate of 9 percent, they will sell at par. 3. Increased use of accounts payable financing. Because this financing is part of the company's ongoing daily business, it has no flotation costs, and the company assigns it a cost that is the same…arrow_forward
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT