財(cái)務(wù)管理基礎(chǔ)斯坦利課后答案

精選優(yōu)質(zhì)文檔-----傾情為你奉上精選優(yōu)質(zhì)文檔-----傾情為你奉上專心---專注---專業(yè)專心---專注---專業(yè)精選優(yōu)質(zhì)文檔-----傾情為你奉上專心---專注---專業(yè)Chapter5DiscussionQuestions5-1.Discussthevarioususesforbreak-evenanalysis.Suchanalysisallowsthefirmtodetermineatwhatlevelofoperationsitwillbreakevenandtoexploretherelationshipbetweenvolume,costs,andprofits.5-2.Whatfactorswouldcauseadifferenceintheuseoffinancialleverageforautilitycompanyandanautomobilecompany?Autilityisinastable,predictableindustryandthereforecanaffordtousemorefinancialleveragethananautomobilecompany,whichisgenerallysubjecttotheinfluencesofthebusinesscycle.Anautomobilemanufacturermaynotbeabletoservicealargeamountofdebtwhenthereisadownturnintheeconomy.5-3.Explainhowthebreak-evenpointandoperatingleverageareaffectedbythechoiceofmanufacturingfacilities(laborintensiveversuscapitalintensive).Alabor-intensivecompanywillhavelowfixedcostsandacorrespondinglylowbreak-evenpoint.However,theimpactofoperatingleverageonthefirmissmallandtherewillbelittlemagnificationofprofitsasvolumeincreases.Acapital-intensivefirm,ontheotherhand,willhaveahigherbreak-evenpointandenjoythepositiveinfluencesofoperatingleverageasvolumeincreases.5-4.Whatroledoesdepreciationplayinbreak-evenanalysisbasedonaccountingflows?Basedoncashflows?Whichperspectiveislongerterminnature?Forbreak-evenanalysisbasedonaccountingflows,depreciationisconsideredpartoffixedcosts.Forcashflowpurposes,itiseliminatedfromfixedcosts.Theaccountingflowsperspectiveislonger-terminnaturebecausewemustconsidertheproblemsofequipmentreplacement.

5-5.Whatdoesrisktakinghavetodowiththeuseofoperatingandfinancialleverage?Bothoperatingandfinancialleverageimplythatthefirmwillemployaheavycomponentoffixedcostresources.Thisisinherentlyriskybecausetheobligationtomakepaymentsremainsregardlessoftheconditionofthecompanyortheeconomy.

5-6.Discussthelimitationsoffinancialleverage.Debtcanonlybeuseduptoapoint.Beyondthat,financialleveragetendstoincreasetheoverallcostsoffinancingtothefirmaswellasencouragecreditorstoplacerestrictionsonthefirm.Thelimitationsofusingfinancialleveragetendtobegreatestinindustriesthatarehighlycyclicalinnature.5-7.Howdoestheinterestrateonnewdebtinfluencetheuseoffinancialleverage?Thehighertheinterestrateonnewdebt,thelessattractivefinancialleverageistothefirm.5-8.Explainhowcombinedleveragebringstogetheroperatingincomeandearningspershare.Operatingleverageprimarilyaffectstheoperatingincomeofthefirm.Atthispoint,financialleveragetakesoveranddeterminestheoverallimpactonearningspershare.AdelineationofthecombinedeffectofoperatingandfinancialleverageispresentedinTable5-6andFigure5-5.5-9.Explainwhyoperatingleveragedecreasesasacompanyincreasessalesandshiftsawayfromthebreak-evenpoint.Atprogressivelyhigherlevelsofoperationsthanthebreak-evenpoint,thepercentagechangeinoperatingincomeasaresultofapercentagechangeinunitvolumediminishes.Thereasonisprimarilymathematical—aswemovetoincreasinglyhigherlevelsofoperatingincome,thepercentagechangefromthehigherbaseislikelytobeless.5-10.Whenyouareconsideringtwodifferentfinancingplans,doesbeingatthelevelwhereearningspershareareequalbetweenthetwoplansalwaysmeanyouareindifferentastowhichplanisselected?Thepointofequalityonlymeasuresindifferencebasedonearningspershare.Sinceourultimategoalismarketvaluemaximization,wemustalsobeconcernedwithhowtheseearningsarevalued.Twoplansthathavethesameearningspersharemaycallfordifferentprice-earningsratios,particularlywhenthereisadifferentialriskcomponentinvolvedbecauseofdebt.

Problems5-1.GatewayAppliancetoasterssellfor$20perunit,andthevariablecosttoproducethemis$15.Gatewayestimatesthatthefixedcostsare$80,000.a. Computethebreak-evenpointinunits.b. Fillinthetablebelow(indollars)toillustratethatthebreak-evenpointhasbeenachieved. Sales _______________ –Fixedcosts _______________ –totalvariablecosts _______________ Netprofit(loss) _______________Solution:GatewayApplianceb. Sales $320,000(16,000unitsx$20) –Fixedcosts 80,000 –Totalvariablecosts 240,000(16,000unitsx$15) Netprofit(loss) $0

5-2.HazardousToysCompanyproducesboomerangsthatsellfor$8eachandhaveavariablecostof$7.50.Fixedcostsare$15,000.a. Computethebreak-evenpointinunits.b. Findthesales(inunits)neededtoearnaprofitof$25,000.Solution:TheHazardousToysCompanya.

5-3.EnscoLightingCompanyhasfixedcostsof$100,000,sellsitsunitsfor$28andhasvariablecostsof$15.50perunit.Computethebreakevenpoint.Ms.Wattscomesupwithanewplantocutfixedcoststo$75,000.However,morelaborwillnowberequired,whichwillincreasevariablecostsperunitto$17.Thesalespricewillremainat$28.Whatisthenewbreakevenpoint?Underthenewplan,whatislikelytohappentoprofitabilityatveryhighvolumelevels(comparedtotheoldplan)?Solution:EnscoLightingCompanya.b. Thebreakevenleveldecreases.c. Withlessoperatingleverageandasmallercontributionmargin,profitabilityislikelytobelessatveryhighvolumelevels.

5-4.AirFilter,Inc.sellsitsproductsfor$6perunit.Ithasthefollowingcosts: Rent $100,000 Factorylabor $1.20perunit Executivesalaries $89,000 Rawmaterial $.60perunitSeparatetheexpensesbetweenfixedandvariablecostperunit.Usingthisinformationandthesalespriceperunitof$6,computethebreak-evenpoint.Solution:AirFilter,Inc.FixedCostsVariableCosts(perunit)Rent$100,000Factorylabor$1.20Executivesalaries$89,000Rawmaterials_______.60$189,000$1.80

5-5.ShawnPenn&PencilSets,Inc.hasfixedcostsof$80,000.Itsproductcurrentlysellsfor$5perunitandhasvariablecostsof$2.50perunit.Mr.Bic,theheadofmanufacturing,proposestobuynewequipmentthatwillcost$400,000anddriveupfixedcoststo$120,000.Althoughthepricewillremainat$5perunit,theincreasedautomationwillreducevariablecostsperunitto$2.00.AsaresultofBic'ssuggestion,willthebreak-evenpointgoupordown?Computethenecessarynumbers.Solution:ShawnPenn&PencilSets,Inc.Thebreak-evenpointwillgoup.5-6.Gibson&Sons,anappliancemanufacturer,computesitsbreak-evenpointstrictlyonthebasisofcashexpendituresrelatedtofixedcosts.Itstotalfixedcostsare$1,200,000,but25percentofthisvalueisrepresentedbydepreciation.Itscontributionmargin(priceminusvariablecost)foreachunitis$2.40.Howmanyunitsdoesthefirmneedtoselltoreachthecashbreak-evenpoint?Solution:Gibson&SonsCashrelatedfixedcosts=TotalFixedCosts–Depreciation =$1,200,000–25%($1,200,000) =$1,200,000–$300,000 =$900,000 5-7.Drawtwobreak-evengraphs—oneforaconservativefirmusinglabor-intensiveproductionandanotherforacapital-intensivefirm.Assumingthesecompaniescompetewithinthesameindustryandhaveidenticalsales,explaintheimpactofchangesinsalesvolumeonbothfirms'profits.Solution:Labor-Intensiveandcapital-intensivebreak-evengraphsThecompanyhavingthehighfixedcostswillhavelowervariablecoststhanitscompetitorsinceithassubstitutedcapitalforlabor.Withalowervariablecost,thehighfixedcostcompanywillhavealargercontributionmargin.Therefore,whensalesrise,itsprofitswillincreasefasterthanthelowfixedcostfirmandwhenthesalesdecline,thereversewillbetrue.

5-8.TheSosaCompanyproducesbaseballgloves.Thecompany’sincomestatementfor2004isasfollows:SosaCompanyIncomeStatementFortheYearEndedDecember31,2004Sales(20,000glovesat$60each) $1,200,000Less:Variablecosts(20,000glovesat$20) 400,000Fixedcosts 600,000Earningsbeforeinterestandtaxes(EBIT) 200,000Interestexpense 80,000Earningsbeforetaxes(EBT) 120,000Incometaxexpense(30%) 36,000Earningsaftertaxes(EAT) $84,000Giventhisincomestatement,computethefollowing:a. Degreeofoperatingleverage.b. Degreeoffinancialleverage.c. Degreeofcombinedleverage.Solution:SosaCompanyQ=20,000,P=$60,VC=$20,FC=$600,000,I=$80,000

5-8.Continued

5-9.TheHarmonCompanymanufacturesskates.Thecompany'sincomestatementfor2004isasfollows:HarmonCompanyIncomeStatementFortheYearEndedDecember31,2004Sales(30,000skates@$25each) $750,000Less:Variablecosts(30,000skatesat$7) 210,000Fixedcosts 270,000Earningsbeforeinterestandtaxes(EBIT) 270,000Interestexpense 170,000Earningsbeforetaxes(EBT) 100,000Incometaxexpense(35%) 35,000Earningsaftertaxes(EAT) $65,000Giventhisincomestatement,computethefollowing:a. Degreeofoperatingleverage.b. Degreeoffinancialleverage.c. Degreeofcombinedleverage.d. Break-evenpointinunits.Solution:HarmonCompanyQ=30,000,P=$25,VC=$7,FC=$270,000,I=$170,000

5-9.Continued

5-10.UniversityCateringsells50-poundbagsofpopcorntouniversitydormitoriesfor$10abag.Thefixedcostsofthisoperationare$80,000,whilethevariablecostsofthepopcornare$.10perpound.a. Whatisthebreak-evenpointinbags?b. Calculatetheprofitorlosson12,000bagsand25,000bags.c. Whatisthedegreeofoperatingleverageat20,000bagsand25,000bags?Whydoesthedegreeofoperatingleveragechangeasthequantitysoldincreases?d. IfUniversityCateringhasanannualinterestpaymentof$10,000,calculatethedegreeoffinancialleverageatboth20,000and25,000bags.e. Whatisthedegreeofcombinedleverageatbothsaleslevels?Solution:UniversityCateringb.12,000bags25,000bagsSales@$10perbag$120,000$250,000Less:VariablesCosts($5)(60,000)(125,000)FixedCosts(80,000)(80,000)ProfitorLoss($20,000)$45,000

5-10.ContinuedLeveragegoesdownbecausewearefurtherawayfromthebreak-evenpoint,thusthefirmisoperatingonalargerprofitbaseandleverageisreduced.Firstdeterminetheprofitorloss(EBIT)at20,000bags.Asindicatedinpartb,theprofit(EBIT)at25,000bagsis$45,000:20,000bagsSales@$10perbag$200,000Less:VariableCosts($5)100,000FixedCosts80,000ProfitorLoss$20,000

5-10.Continued5-11.Leno’sDrugStoresandHall’sPharmaceuticalsarecompetitorsinthediscountdrugchainstorebusiness.TheseparatecapitalstructuresforLenoandHallarepresentedbelow.LenoHallDebt@10% $100,000Debt@10% $200,000Commonstock,$10par 200,000Commonstock,$10par 100,000Total $300,000Total $300,000Shares 20,000Commonshares 10,000

5-11.Continueda. Computeearningspershareifearningsbeforeinterestandtaxesare$20,000,$30,000,and$120,000(assumea30percenttaxrate).b. ExplaintherelationshipbetweenearningspershareandthelevelofEBIT.c. Ifthecostofdebtwentupto12percentandallotherfactorsremainedequal,whatwouldbethebreak-evenlevelforEBIT?Solution:LenoDrugStoresandHallPharmaceuticalsa.LenoHallEBIT$20,000$20,000Less:Interest10,00020,000EBT10,0000Less:Taxes@30%3,0000EAT7,0000Shares20,00010,000EPS$.350EBIT$30,000$30,000Less:Interest10,00020,000EBT20,00010,000Less:Taxes@30%6,0003,000EAT14,0007,000Shares20,00010,000EPS$.70$.70EBIT$120,000$120,000Less:Interest1000020,000EBT110,000100,000Less:Taxes@30%33,00030,000EAT77,00070,000Shares20,00010,000EPS$3.85$7.00

5-11.Continuedb. Before-taxreturnonassets=6.67%,10%and40%attherespectivelevelsofEBIT.Whenthebefore-taxreturnonassets(EBIT/TotalAssets)islessthanthecostofdebt(10%),LenodoesbetterwithlessdebtthanHall.Whenbefore-taxreturnonassetsisequaltothecostofdebt,bothfirmshaveequalEPS.ThiswouldbewherethemethodoffinancinghasaneutraleffectonEPS.Asreturnonassetsbecomesgreaterthantheinterestrate,financialleveragebecomesmorefavorableforHall.c. 12%x$300,000=$36,000break-evenlevelforEBIT.5-12.InProblem11,computethestockpriceforHallPharmaceuticalsifitsellsat13timesearningspershareandEBITis$80,000.Solution:HallPharmaceuticals(Continued)EBIT$80,000Less:Interest20,000EBT$60,000Less:Taxes@30%18,000EAT$42,000Shares10,000EPS$4.20P/E13xStockPrice$54.60

5-13.PulpPaperCompanyandHoltPaperCompanyareabletogenerateearningsbeforeinterestandtaxesof$150,000.TheseparatecapitalstructuresforPulpandHoltareshownbelow:PulpHoltDebt@10% $800,000Debt@10% $400,000Commonstock,$5par 700,000Commonstock,$5par 1,100,000Total $1,500,000Total $1,500,000Commonshares 140,000Commonshares 220,000a. Computeearningspershareforbothfirms.Assumea40percenttaxrate.b. Inparta,youshouldhavegottenthesameanswerforbothcompanies'earningspershare.AssumeaP/Eratioof20foreachcompany,whatwoulditsstockpricebe?c. Nowaspartofyouranalysis,assumetheP/Eratiowouldbe15fortheriskiercompanyintermsofheavydebtutilizationinthecapitalstructureand26forthelessriskycompany.Whatwouldthestockpricesforthetwofirmsbeundertheseassumptions?(Note:Althoughinterestratesalsowouldlikelybedifferentbasedonrisk,weholdthemconstantforeaseofanalysis).d. Basedontheevidenceinpartc,shouldmanagementonlybeconcernedabouttheimpactoffinancingplansonearningspershareorshouldstockholders'wealthmaximization(stockprice)beconsideredaswell?

Solution:PulpPaperCompanyandHoltPaperCompanya.PulpHoltEBIT$150,000$150,000Less:Interest80,00040,000EBT70,000110,000Less:Taxes@40%28,00044,000EAT42,00066,000Shares140,000220,000EPS$.30$.30b. Stockprice =P/ExEPS 20x$.30=$6.00c. Pulp Holt 15x$.30=$4.50 26x$.30=$7.80d. Clearly,theultimateobjectiveshouldbetomaximizethestockprice.Whilemanagementwouldbeindifferentbetweenthetwoplansbasedonearningspershare,HoltPaper,withthelessriskyplan,hasahigherstockprice.

5-14.FirmsinJapanoftenemploybothhighoperatingandfinancialleveragebecauseoftheuseofmoderntechnologyandcloseborrower-lenderrelationships.AssumetheSusakiCompanyhasasalesvolumeof100,000unitsatapriceof$25perunit;variablecostsare$5perunitandfixedcostsare$1,500,000.Interestexpenseis$250,000.WhatisthedegreeofcombinedleverageforthisJapanesefirm?Solution:SusakiCompany

5-15.GlynnEnterprisesandMonroe,Inc.,bothproducefluidcontrolproducts.Theirfinancialinformationisasfollows:CapitalStructureGlynnMonroeDebt@10% $1,500,0000Commonstock,$10pershare 500,000$2,000,000$2,000,000$2,000,000Commonshares 50,000200,000OperatingPlanSales(200,000unitsat$5each) $1,000,000$1,000,000Less:Variablecosts 600,000200,000($3perunit)($1perunit)Fixedcosts 0400,000Earningsbeforeinterestandtaxes(EBIT) $400,000$400,000a. IfyoucombineGlynn’scapitalstructurewithMonroe’soperatingplan,whatisthedegreeofcombinedleverage?b. IfyoucombineMonroe’scapitalstructurewithGlynn’soperatingplan,whatisthedegreeofcombinedleverage?c. Explainwhyyougottheresultsyoudidinpartb.d. Inpartb,ifsalesdouble,bywhatpercentwillEPSincrease?

ContinuedSolution:GlynnEnterprisesandMonroe,Inc.

5-15.Continuedc. Thecombinedleverageisfairlyhighinpartabecauseyouarecombiningfirmsthatbothuseoperatingandfinancialleverage.However,theleveragefactorisonlyoneinpartbbecauseMonroehasnofinancialleverageandGlynnhasnooperatingleverage.d. EPSwillincreaseby100percent.However,thereisnoleverageinvolved.EPSmerelygrowsatthesamerateassales.5-16.DeSotoTools,Inc.,isplanningtoexpandproduction.Theexpansionwillcost$300,000,whichcanbefinancedeitherbybondsataninterestrateof14percentorbyselling10,000sharesofcommonstockat$30pershare.Thecurrentincomestatementbeforeexpansionisasfollows:DeSotoTools,Inc.

IncomeStatement

199XSales $1,500,000Less:Variablecosts $450,000Fixedcosts 550,0001,000,000Earningsbeforeinterestandtaxes 500,000Less:Interestexpense 100,000Earningsbeforetaxes 400,000Less:Taxes@34% 136,000Earningsaftertaxes $264,000Shares 100,000Earningspershare $2.64Aftertheexpansion,salesareexpectedtoincreaseby$1,000,000.Variablecostswillremain30percentofsales,andfixedcostswillincreaseto$800,000.Thetaxrateis34percent.a. Calculatethedegreeofoperatingleverage,thedegreeoffinancialleverage,andthedegreeofcombinedleveragebeforeexpansion.(Forthedegreeofoperatingleverage,usetheformuladevelopedinfootnote2;forthedegreeofcombinedleverage,usetheformuladevelopedinfootnote3.Theseinstructionsapplythroughoutthisproblem.)

5-16.Continuedb. Constructtheincomestatementforthetwoalternativefinancingplans.c. Calculatethedegreeofoperatingleverage,thedegreeoffinancialleverage,andthedegreeofcombinedleverage,afterexpansion.d. Explainwhichfinancingplanyoufavorandtherisksinvolvedwitheachplan.Solution:DeSotoTools,Inc.

5-16.Continuedb. IncomeStatementAfterExpansionDebtEquitySales$2,500,000$2,500,000Less:VariableCosts(30%)750,000750,000FixedCosts800,000800,000EBIT950,000950,000Less:Interest142,0001100,000EBT808,000850,000Less:Taxes@34%274,720289,000EAT(NetIncome)533,280561,000CommonShares100,000110,0002EPS$5.33$5.101 Newinterestexpenselevelifexpansionisfinancedwithdebt. $100,000+14%($300,000)=$142,0002 Numberofcommonsharesoutstandingifexpansionis

financedwithequity. 100,000+10,000=110,000

5-16.Continuedc.

5-16.Continuedd. Thedebtfinancingplanprovidesagreaterearningspershareatthenewsaleslevel,butprovidesmoreriskbecauseoftheincreaseduseofdebt.However,theinterestcoverageratioinbothcasesiscertainlysatisfactoryandinterestexpenseiswellprotected.Thecrucialpointisexpectationsforfuturesales.Ifsalesareexpectedtodecline,thedebtplanwillnotprovidehigherEPSatsalesoflessthanabout$2millionsocyclicalswingsinsales,earnings,andprofitmarginsneedtobeconsideredinchoosingthefinancingplan.5-17.UsingStandard&Poor’sdataorannualreports,comparethefinancialandoperatingleverageofExxon,EastmanKodak,andDeltaAirlinesforthemostcurrentyear.Explaintherelationshipbetweenoperatingandfinancialleverageforeachcompanyandtheresultantcombinedleverage.Whataccountsforthedifferencesinleverageofthesecompanies?Solution:Theresultsforthisproblemchangeeveryyear.Thisisprimarilyalibraryassignmenttofacilitateclassdiscussion.

5-18.DickinsonCompanyhas$12millioninassets.Currentlyhalfoftheseassetsarefinancedwithlong-termdebtat10percentandhalfwithcommonstockhavingaparvalueof$8.Ms.Smith,vice-presidentoffinance,wishestoanalyzetworefinancingplans,onewithmoredebt(D)andonewithmoreequity(E).Thecompanyearnsareturnonassetsbeforeinterestandtaxesof10percent.Thetaxrateis45percent.UnderPlanD,a$3millionlong-termbondwouldbesoldataninterestrateof12percentand375,000sharesofstockwouldbepurchasedinthemarketat$8pershareandretired.UnderPlanE,375,000sharesofstockwouldbesoldat$8pershareandthe$3,000,000inproceedswouldbeusedtoreducelong-termdebt.a. Howwouldeachoftheseplansaffectearningspershare?Considerthecurrentplanandthetwonewplans.b. Whichplanwouldbemostfavorableifreturnonassetsfellto5percent?Increasedto15percent?Considerthecurrentplanandthetwonewplans.c. Ifthemarketpriceforcommonstockroseto$12beforetherestructuring,whichplanwouldthenbemostattractive?Continuetoassumethat$3millionindebtwillbeusedtoretirestockinPlanDand$3millionofnewequitywillbesoldtoretiredebtinPlanE.Alsoassumeforcalculationsinpartcthatreturnonassetsis10percent.

Solution:DickinsonCompanyIncomeStatementsa. Returnonassets=10% EBIT=$1,200,000CurrentPlanDPlanEEBIT$1,200,000$1,200,000$1,200,000Less:Interest600,0001960,0002300,0003EBT600,000240,000900,000Less:Taxes(45%)270,000108,000405,000EAT330,000132,000495,000Commonshares750,0004375,0001,125,000EPS$.44$.35$.441 $6,000,000debt@10%2 $600,000interest+($3,000,000debt@12%)3 ($6,000,000–$3,000,000debtretired)x10%4 ($6,000,000commonequity)/($8parvalue)=750,000sharesPlanEandtheoriginalplanprovidethesameearningspersharebecausethecostofdebtat10percentisequaltotheoperatingreturnonassetsof10percent.WithPlanD,thecostofincreaseddebtrisesto12percent,andthefirmincursnegativeleveragereducingEPSandalsoincreasingthefinancialrisktoDickinson.

5-18.Continuedb. Returnonassets=5% EBIT=$600,000CurrentPlanDPlanEEBIT$600,000$600,000$600,000Less:Interest600,000960,000300,000EBT0(360,000)300,000Less:Taxes@45%--- (162,000)135,000EAT0 $(198,000)$165,000Commonshares750,000375,0001,125,000EPS0$(.53)$.15 Returnonassets=15% EBIT=$1,800,000CurrentPlanDPlanEEBIT$1,800,000$1,800,000$1,800,000Less:Interest600,000960,000300,000EBT1,200,000840,0001,500,000Less:Taxes@45%540,000378,000675,000EAT$660,000$462,000$825,000Commonshares750,000375,0001,125,000EPS$.88$1.23$.73Ifthereturnonassetsdecreasesto5%,PlanEprovidesthebestEPS,andat15%return,PlanDprovidesthebestEPS.PlanDisstillrisky,havinganinterestcoverageratiooflessthan2.0.

5-18.Continuedc. ReturnonAssets=10%EBIT=$1,200,000CurrentPlanDPlanEEBIT$1,200,000$1,200,000$1,200,000EAT330,000132,000495,000Commonshares750,000500,00011,000,0002EPS$.44$.26$.501 750,000–($3,000,000/$12pershare) =750,000–250,000=500,000shares2 750,000+($3,000,000/$12pershare) =750,000+250,000=1,000,000sharesAsthepriceofthecommonstockincreases,PlanEbecomesmoreattractivebecausefewersharescanberetiredunderPlanDand,bythesamelogic,fewersharesneedtobesoldunderPlanE.5-19.JohnsonGrassandGardenCentershas$20millioninassets,75percentfinancedbydebtand25percentfinancedbycommonstock.Theinterestrateonthedebtis12percentandtheparvalueofthestockis$10pershare.PresidentJohnsonisconsideringtwofinancingplansforanexpansionto$30millioninassets.UnderPlanA,thedebt-to-totalassetsratiowillbemaintained,butnewdebtwillcost15percent!Newstockwillbesoldat$10pershare.UnderPlanB,onlynewcommonstockat$10persharewillbeissued.Thetaxrateis40percent.a. IfEBITis12percentontotalassets,computeearningspershare(EPS)beforetheexpansionandunderthetwoalternatives.b. Whatisthedegreeoffinancialleverageundereachofthethreeplans?c. Ifstockcouldbesoldat$20pershareduetoincreasedexpectationsforthefirm'ssalesandearnings,whatimpactwouldthishaveonearningspershareforthetwoexpansionalternatives?Computeearningspershareforeach.d. Explainwhycorporatefinancialofficersareconcernedabouttheirstockvalues!

5-19.ContinuedSolution:JohnsonGrassandGardenCentersa. ReturnonAssets=12%CurrentPlanAPlanBEBIT$2,400,000$3,600,000$3,600,000Less:Interest1,800,00012,925,00031,200,0005EBT600,000675,0001,800,000Less:Taxes@

40%240,000270,000720,000EAT$360,000$405,000$1,080,000Commonshares500,0002750,00041,500,0006EPS$.72$.54$.721 (75%x$20,000,000)x12%=$15,000,000x12%=$1,800,0002 (25%x$20,000,000)/$10=$5,000,000/$10= 500,000shares3 $1,800,000(current)+(75%x$10,000,000)x15%

=$1,800,000+$1,125,000=$2,925,0004 500,000shares(current)+(25%x$10,000,000)/$10

=500,000+250,000=750,000shares5 unchanged6 500,000shares(current)+$10,000,000/$10= 500,000+1,000,000=1,500,000shares

5-19.Continued

b.c. PlanAPlanBEAT$405,000$1,080,000CommonShares625,00011,000,0002EPS$.65$1.081 500,000shares(current)+(25%x$10,000,000)/$20

=500,000+125,000=625,000shares2 500,000shares(current)+$10,000,000/$20

=500,000+500,000=1,000,000shares PlanBwouldcontinuetoprovidethehigherearningspersharethanPlanA.ThedifferencebetweenplansAandBisevengreaterthanthatindicatedinpart(a).

5-19.Continuedd. Notonlydoesthepriceofthecommonstockcreatewealthtotheshareholder,whichisthemajorobjectiveofthefinancialmanager,butitgreatlyinfluencestheabilitytoraisecapitaltofinanceprojectsatahighorlowcost.CostofcapitalwillbediscussedinChapter10,andonewillseetheimpactthatthecostofcapitalhasoncapitalbudgetingdecisions.5-20.Mr.Katzisinthewidgetbusiness.Hecurrentlysells2millionwidgetsayearat$4each.Hisvariablecosttoproducethewidgetsis$3perunit,andhehas$1,500,000infixedcosts.Hissales-to-assetsratioisfourtimes,and40percentofhisassetsarefinancedwith9percentdebt,withthebalancefinancedbycommonstockat$10pershare.Thetaxrateis30percent.Hisbrother-in-law,Mr.Doberman,saysMr.Katzisdoingitallwrong.Byreducinghispriceto$3.75awidget,hecouldincreasehisvolumeofunitssoldby40percent.Fixedcostswouldremainconstant,andvariablecostswouldremain$3perunit.Hissales-to-assetsratiowouldbe5times.Furthermore,hecouldincreasehisdebt-to-assetsratioto50percent,withthebalanceincommonstock.Itisassumedthattheinterestratewouldgoupby1percentandthepriceofstockwouldremainconstant.a. ComputeearningspershareundertheKatzplan.b. ComputeearningspershareundertheDobermanplan.c. Mr.Katz’swifedoesnotthinkthatfixedcostswouldremainconstantundertheDobermanplanbutthattheywouldgoupby20percent.Ifthisisthecase,shouldMr.KatzshifttotheDobermanplan,basedonearningspershare?

5-20.ContinuedSolution:Katz-Dobermana. KatzPlanSales($2,000,000unitsx$4) $8,000,000–Fixedcosts –1,500,000–Variablecosts(2,000,000unitsx$3) –6,000,000Operatingincome(EBIT) $500,000–Interest1 72,000EBT $428