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Chapter 2: Q25BP-b (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.

b. What is the degree of financial leverage under each of the three plans?

Short Answer

Expert verified

Degree of financial leverage under the current plan is 5, Under plan A is 11.07 and under plan B is 1.89.

Step by step solution

01

Calculation of EBIT and EBT

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

02

Degree of financial leverage under current option

Degreeoffinancialleverage=EBITEBT=$954,000$190,800=5

03

Degree of financial leverage under Option A

Degreeoffinancialleverage=EBITEBT=$1,620,000$146,400=11.07

04

Degree of financial leverage under option B

Degreeoffinancialleverage=EBITEBT=$1,620,000$856,800=1.89

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Most popular questions from this chapter

Amigo Software Inc. has total assets of \(889,000, current liabilities of\)192,000, and long-term liabilities of \(154,000. There is \)87,000 in preferredstock outstanding. Thirty thousand shares of common stock have been issued.

a. Compute book value (net worth) per share.

b. If there is $56,300 in earnings available to common stockholders and the

firm鈥檚 stock has a P/E of 23 times earnings per share, what is the currentprice of the stock?

c. What is the ratio of market value per share to book value per share? (Round

to two places to the right of the decimal point.)

Botox Facial Care had earnings after taxes of \(370,000 in 20X1 with 200,000 shares of stock outstanding. The stock price was \)31.50. In 20X2, earnings after taxes increased to \(436,000 with the same 200,000 shares outstanding. The stock price was \)42.00

a. Compute earnings per share and the P/E ratio for 20X1. The P/E ratio

equals the stock price divided by earnings per share.

b. Compute earnings per share and the P/E ratio for 20X2.

c. Give a general explanation of why the P/E ratio changed.

What are the three primary sections of the statement of cash flows? In what section would the payment of a cash dividend be shown?

The Lancaster Corporation鈥檚 income statement is given below.

a. What is the times-interest-earned ratio?

Lancaster corporation

Sales

\(246,000

Cost of goods sold

122,000

Gross profit

\)124,000

Fixed charges (other than interest)

27,500

Income before interest and taxes

\(96,500

Interest

21,800

Income before taxes

\)74,700

Taxes (35%)

26,145

Income after taxes

$48,555

For December 31, 20X1, the balance sheet of Baxter Corporation was as follows:

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

Sales for 20X2 were \)245,000, and the cost of goods sold was 60 percent of sales. Selling and administrative expense was \(24,500. Depreciation expense was 8 percent of plant and equipment (gross) at the beginning of the year. Interest expense for the notes payable was 10 percent, while the interest rate on the bonds payable was 12 percent. This interest expense is based on December 31, 20X1 balances. The tax rate averaged 20 percent.

\)2,500 in preferred stock dividends were paid, and \(5,500 in dividends were paid to common stockholders. There were 10,000 shares of common stock outstanding.

During 20X2, the cash balance and prepaid expenses balances were

unchanged. Accounts receivable and inventory increased by 10 percent. A new machine was purchased on December 31, 20X2, at a cost of \)40,000. Accounts payable increased by 20 percent. Notes payable increased by \(6,500 and bonds payable decreased by \)12,500, both at the end of the year. The preferred stock, common stock, and paid-in capital in excess of par accounts did not change.

a. Prepare an income statement for 20X2.
See all solutions

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