The Lopez-Portillo Company has $10.9 million in assets, 90 percent financed by d

Question

The Lopez-Portillo Company has $10.9 million in assets, 90 percent financed by debt and 10 percent financed by common stock. The interest rate on the debt is 6 percent and the par value of the stock is $10 per share. President Lopez-Portillo is considering two financing plans for an expansion to $19.5 million in assets.

Under Plan A, the debt-to-total-assets ratio will be maintained, but new debt will cost a whopping 7 percent! Under Plan B, only new common stock at $10 per share will be issued. The tax rate is 40 percent.

a. If EBIT is 7 percent on total assets, compute earnings per share (EPS) before the expansion and under the two alternatives. (Round your answers to 2 decimal places.)
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.)
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.)
Plan A _______
Plan B _______

Explanation / Answer

First of all let's prepare statement amount of debt and equity in current plan and proposed

Statement showing EPS

b) DLF = EBIT/EBT

c) Statement showing new shares to be issued

Statement showing new EPS

Particulars Current Plan A Plan B Total Asset 10900000 19500000 19500000 Amount of debt(90%) 9810000 9810000 9810000 Additional debt 7740000 Equity 1090000 1950000 9690000

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