Dickinson Company has $12,100,000 million in assets. Currently half of these ass
ID: 2813683 • Letter: D
Question
Dickinson Company has $12,100,000 million in assets. Currently half of these assets are financed with long-term debt at 10.5 percent and half with common stock having a par value of $8. Ms. Smith, Vice President of Finance, wishes to analyze two refinancing plans, one with more debt (D) and one with more equity (E). The company earns a return on assets before interest and taxes of 10.5 percent. The tax rate is 40 percent. Tax loss carryover provisions apply, so negative tax amounts are permissable.
Under Plan D, a $3,025,000 million long-term bond would be sold at an interest rate of 12.5 percent and 378,125 shares of stock would be purchased in the market at $8 per share and retired.
Under Plan E, 378,125 shares of stock would be sold at $8 per share and the $3,025,000 in proceeds would be used to reduce long-term debt.
a. How would each of these plans affect earnings per share? Consider the current plan and the two new plans. (Round your answers to 2 decimal places.)
b-1. Compute the earnings per share if return on assets fell to 5.25 percent. (Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.)
b-2. Which plan would be most favorable if return on assets fell to 5.25 percent? Consider the current plan and the two new plans.
b-3. Compute the earnings per share if return on assets increased to 15.5 percent. (Round your answers to 2 decimal places.)
b-4. Which plan would be most favorable if return on assets increased to 15.5 percent? Consider the current plan and the two new plans.
c-1. If the market price for common stock rose to $10 before the restructuring, compute the earnings per share. Continue to assume that $3,025,000 million in debt will be used to retire stock in Plan D and $3,025,000 million of new equity will be sold to retire debt in Plan E. Also assume that return on assets is 10.5 percent. (Round your answers to 2 decimal places.)
c-2. If the market price for common stock rose to $10 before the restructuring, which plan would then be most attractive?
Plan D Current Plan Plan EExplanation / Answer
(a)Computation of the earning per share(EPS) in current plan and two new plan.We have,
Step1: Computation of the earning before interest and taxes(EBIT).We have,
EBIT = Value of Asset x return on assets before interest and taxes
EBIT = 12,100,000 X 10.5% = $ 1,270,500
Step2: Computation of the interest on debt.We have,
Current plan:
Interest on debt = 12,100,000/2 x 10.5% = $ 635,250
Plan D:
Interest on debt = (12,100,000/2 x 10.5%) + ( 3,025,000 x 12.5%)
Interest on debt = 635,250 + 378,125 = $ 1,013,375
Plan E:
Interest on debt = 3,025,000 x 10.5 % = $ 317,625
Step3: Computation of the Number of share outstanding in all plan.We have,
Current plan:
Number of share = value of equity share capital / price per share
Number of share = (12,100,000/2) / 8 = 756,250
Plan D:
Number of share = 756,250 - 378,125 = 378,125
Plan E:
Number of share = 756,250 + 378,125 = 1,134,375
Step4: Computation of the EPS under all plan.We have,
(B-1)Computation of the earnings per share if return on assets fell to 5.25 percent.We have,
Step1: Computation of the earning before interest and taxes(EBIT).We have,
EBIT = Value of Asset x return on assets before interest and taxes
EBIT = 12,100,000 X 5.25% = $ 635,250
Step2: Computation of the EPS under all plan.We have,
(b-2)
Plan E is most favourabe if return on assets fell to 5.25 percent. It is because it earns earning per share at $ 0.17 and other two are zero and negative earnings.
(b-3) Computation of the earnings per share if return on assets increased to 15.5 percent. We have,
Step1: Computation of the earning before interest and taxes(EBIT).We have,
EBIT = Value of Asset x return on assets before interest and taxes
EBIT = 12,100,000 X 15.5% = $ 1,875,500
Step2: Computation of the EPS under all plan.We have,
(b-4)
Plan D is most favourabe if return on assets rise to 15.5 percent. It is because it earns earning per share at $ 01.37 which is higher from other two plan.
(c-1) Computation of the EPS when share price rise to $10.00.We have,
Step1: Computation of the earning before interest and taxes(EBIT).We have,
EBIT = Value of Asset x return on assets before interest and taxes
EBIT = 12,100,000 X 10.5% = $ 1,270,500
Step2: Computation of the interest on debt.We have,
Current plan:
Interest on debt = 12,100,000/2 x 10.5% = $ 635,250
Plan D:
Interest on debt = (12,100,000/2 x 10.5%) + ( 3,025,000 x 12.5%)
Interest on debt = 635,250 + 378,125 = $ 1,013,375
Plan E:
Interest on debt = 3,025,000 x 10.5 % = $ 317,625
Step3: Computation of the Number of share outstanding in all plan.We have,
Current plan:
Number of share = value of equity share capital / price per share
Number of share = (12,100,000/2) / 10 = 605,000
Plan D:
Number of share = 605,000 - 378,125 = 226,875
Plan E:
Number of share = 605,000 + 378,125 = 983,125
Step4: Computation of the EPS under all plan.We have,
(c-2)
If the market price for common stock rose to $10 before the restructuring, plan D would be most attractive. It is because plan D EPS is higher than other two plan.
Particulars Current Plan Plan D Plan E EBIT $ 1,270,500 $ 1,270,500 $ 1,270,500 Less: Interest expense $ 635,250 1,013,375 $ 317,625 Earning before taxes $ 635,250 $ 257,125 $ 952,875 Less: Taxes@ 40% $ 254,100 $ 102,850 $ 381,150 Earning after taxes $ 381,150 $ 154,275 $ 571,725 / Number of share outstanding 756,250 378,125 1,134,375 Earning per share(EPS) $ 0.50 0.41 0.50Related Questions
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