Dickinson Company has $11,920,000 million in assets. Currently half of these ass

Question

Dickinson Company has $11,920,000 million in assets. Currently half of these assets are financed with long-term debt at 9.6 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 9.6 percent. The tax rate is 35 percent. Tax loss carryover provisions apply, so negative tax amounts are permissable Under Plan D, a $2,980,000 million long-term bond would be sold at an interest rate of 11.6 percent and 372,500 shares of stock would be purchased in the market at $8 per share and retired Under Plan E, 372,500 shares of stock would be sold at $8 per share and the $2,980,000 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.) Current Plan Plan D Plan E Earnings per share

Explanation / Answer

a) Dickinson Company Income Statement Current Plan Plan D Plan E EBIT $1,144,320.00 $1,144,320.00 $1,144,320.00 Less: Interest $572,160.00 $917,840.00 $286,080.00 EBT $572,160.00 $226,480.00 $858,240.00 Less: Tax @ 35% $200,256.00 $79,268.00 $300,384.00 Net Income $371,904.00 $147,212.00 $557,856.00 Common shares 745000 372500 1117500 EPS $0.50 $0.40 $0.50 Plan E and the original plan provide the same earnings per share because the cost of debt at 9.6 is equal to the operating return on assets of 9.6%. With Plan D, the cost of increased debt rises to 11.6 %, and the firm incurs negative leverage reducing EPS and also increasing the financial risk to Dickinson. EBIT = $11,920,000 x 9.6% $1,144,320.00 Interest under Current Plan = $11,920,000/2 x 9.6% $572,160.00 Interest under Plan D = $11,920,000/2 x 9.6% + 2,980,000 x 11.6% $917,840.00 Interest under Plan E = $11,920,000/2 x 9.6% - 2,980,000 x 9.6% $286,080.00 # common Shares Current Plan = $11,920,000/2 / $8 745000 Shares Plan D = 372500 (given) Plan E = 372500 + 745000 1117500 b-1 Dickinson Company Income Statement Current Plan Plan D Plan E EBIT $572,160.00 $572,160.00 $572,160.00 Less: Interest $572,160.00 $917,840.00 $286,080.00 EBT $0.00 -$345,680.00 $286,080.00 Less: Tax @ 35% $0.00 -$120,988.00 $100,128.00 Net Income $0.00 -$224,692.00 $185,952.00 Common shares 745000 372500 1117500 EPS $0.00 -$0.60 $0.17 EBIT = $11,920,000 x 4.8% $572,160.00 Interest under Current Plan = $11,920,000/2 x 9.6% $572,160.00 Interest under Plan D = $11,920,000/2 x 9.6% + 2,980,000 x 11.6% $917,840.00 Interest under Plan E = $11,920,000/2 x 9.6% - 2,980,000 x 9.6% $286,080.00 # common Shares Current Plan = $11,920,000/2 / $8 745000 Shares Plan D = 372500 (given) Plan E = 372500 + 745000 1117500 b-2 If the return on assets decreases to 4.8%, Plan E provides the best EPS Plan E b-3 Dickinson Company Income Statement Current Plan Plan D Plan E EBIT $1,740,320.00 $1,740,320.00 $1,740,320.00 Less: Interest $572,160.00 $917,840.00 $286,080.00 EBT $1,168,160.00 $822,480.00 $1,454,240.00 Less: Tax @ 35% $408,856.00 $287,868.00 $508,984.00 Net Income $759,304.00 $534,612.00 $945,256.00 Common shares 745000 372500 1117500 EPS $1.02 $1.44 $0.85 EBIT = $11,920,000 x 14.6% $1,740,320.00 Interest under Current Plan = $11,920,000/2 x 9.6% $572,160.00 Interest under Plan D = $11,920,000/2 x 9.6% + 2,980,000 x 11.6% $917,840.00 Interest under Plan E = $11,920,000/2 x 9.6% - 2,980,000 x 9.6% $286,080.00 # common Shares Current Plan = $11,920,000/2 / $8 745000 Shares Plan D = 372500 (given) Plan E = 372500 + 745000 1117500 b-4 If the return on assets increases to 14.6%, Plan D provides the best EPS Plan D c) Dickinson Company Income Statement Current Plan Plan D Plan E EBIT $1,144,320.00 $1,144,320.00 $1,144,320.00 Less: Interest $572,160.00 $917,840.00 $286,080.00 EBT $572,160.00 $226,480.00 $858,240.00 Less: Tax @ 35% $200,256.00 $79,268.00 $300,384.00 Net Income $371,904.00 $147,212.00 $557,856.00 Common shares 745000 447000 1043000 EPS $0.50 $0.33 $0.53 EBIT = $11,920,000 x 9.6% $1,144,320.00 Interest under Current Plan = $11,920,000/2 x 9.6% $572,160.00 Interest under Plan D = $11,920,000/2 x 9.6% + 2,980,000 x 11.6% $917,840.00 Interest under Plan E = $11,920,000/2 x 9.6% - 2,980,000 x 9.6% $286,080.00 # common Shares Current Plan = $11,920,000/2 / $8 745000 Shares Plan D = 745000 - 2,980,000/10 447000 Plan E = 745000 + 2980000/10 1043000 C-2 Plan E

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