Q25BP-a The Lopez-Portillo Company has \... [FREE SOLUTION]

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Foundations Of Financial Management

Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen

Business Studies

16th Edition 路 768 pages

ISBN: 9781259277160

Chapter 2: Q25BP-a (page 152)

The Lopez-Portillo Company has $10.6 million in assets, 80 percent financed by debt and 20 percent financed by common stock. The interest rate on the debt is 9 percent and the par value of the stock is $10 per share. President Lopez-Portillo is considering two financing plans for an expansion to $18 million in assets.
Under Plan A, the debt-to-total-assets ratio will be maintained, but new debt
will cost a whopping 12 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 9 percent on total assets, compute earnings per share (EPS) before
the expansion and under the two alternatives.

Short Answer

Expert verified

The EPS of the company before expansion under the current plan is $0.54, under plan A is $0.244 and under plan B is $0.54.

Step by step solution

Number of shares under the current plan

Total Assets	$10,600,000
Equity = 20% of total assets	$2,120,000 ($10,600,000 x 20%)
No. of shares (Equity/Par value)	212,000 ($2,120,000/$10)

Number of shares under plan A

Total Assets	$18,000,000
Equity = 20% of total assets	$3,600,000 ($18,000,000 x 20%)
No. of shares (Equity/Par value)	360,000 ($3,600,000/$10)

Number of shares under plan B

Total Assets	$18,000,000
Equity (Equity under current plan)	$2,120,000 ($10,600,000 x 20%)
Add: Additional equity issued ($18,000,000-$10,600,000)	$7,400,000
Balance equity	$9,520,000
No. of shares (Equity/Par value)	952,000 ($9,520,000/$10)

EBIT under current plan

$\begin{array}{rcl} EBIT & = & Totalassets 脳 Returnonassets \\ = & $ 10, 600, 000 脳 9 % \\ = & $ 954, 000 \end{array}$

EBIT under Plan A & B

$\begin{array}{rcl} EBIT & = & Totalassets 脳 Returnonassets \\ = & $ 18, 000, 000 脳 9 % \\ = & $ 1, 620, 000 \end{array}$

Interest expense under current plan

$\begin{array}{rcl} Interest & = & Longtermdebt 脳 Interestrate \\ = & ($ 10, 600, 000 脳 0.80) 脳 9 % \\ = & $ 763, 200 \end{array}$

Interest expense under plan A

$\begin{array}{rcl} Interest & = & (ExistingLongtermdebt 脳 Interestrate) + (Newlongtermbondissue 脳 Interestrate) \\ = & ($ 8, 480, 000 脳 9 %) + ($ 5, 920, 000 脳 12 %) \\ = & $ 1, 473, 600 \end{array}$

Interest expense under plan B

$\begin{array}{rcl} Interest & = & Longtermdebt 脳 Interestrate \\ = & ($ 10, 600, 000 脳 0.80) 脳 9 % \\ = & $ 763, 200 \end{array}$

Calculation of EPS

Particulars	Current Plan	Plan A	Plan B
EBIT	954,000	1,620,000	1,620,000
Less: Interest	763,200	1,473,600	763,200
EBT	190,800	146,400	856,800
Less: Tax @40%	76,320	58,560	342,720
Net Income (A)	114,480	87,840	514,080
No. of shares (B)	212,000	360,000	952,000
EPS (A/B)	0.54	0.244	0.54

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Balance sheet 20X1
Assets		Liabilities and Equity
Cash	\)60,000	Account payable	\(220,000
Account receivable	240,000	Accrued taxes	30,000
Inventory	350,000	Bonds payable (long term)	150,000
Plant and equipment	410,000	Common stock	80,000
		Paid in capital	200,000
		Retained earnings	380,000
Total assets	\)1,060,000	Total LIbilities and Equity	$1,060,000

Selling and administrative expenses	$328,000
Depreciation expenses	195,000
Sales	1,660,000
Interest expenses	129,000
Cost of goods sold	560,000
Taxes	171,000

Current assets		Liabilities
Cash	\(15,000	Accounts payable	\)17,000
Accounts receivable	20,000	Notes payable	25,000
Inventory	30,000	Bonds payable	55,000
Prepaid expenses	12,500

Fixed assets		Stockholder鈥檚 equity
Plant and equipment (gross) Less: accumulated depreciation	\(255,000 51,000	Preferred stock	\)25,000
Net plant and equipment	\(204,000	Common stock	60,000
		Paid in capital	30,000
		Retained earnings	69,500
Total assets	\)281,500	Total liabilities and stockholder鈥檚 equity	\(281,500

	20X1	20X2
Sales	\(3,230,000	\)3,370,000
Cost of goods sold	2,130,000	2,850,000
Gross profits	\(1,100,000	\)520,000
Selling and administrative expenses	298,000	227,000
Operating profits	\(802,000	\)293,000
Interest expense	47,200	51,600
Income before taxes	\(754,800	\)241,400
Taxes (35%)	264,180	84,490
Income after tax	\(490,620	\)156,910

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Short Answer

Step by step solution

Number of shares under the current plan

Number of shares under plan A

Number of shares under plan B

EBIT under current plan

EBIT under Plan A & B

Interest expense under current plan

Interest expense under plan A

Interest expense under plan B

Calculation of EPS

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