ABC Investments Inc. is currently managing a capital structure that includes a $3.5 million debt with an interest rate of 12.3%. The company is planning a $5 million expansion initiative and is evaluating five financing alternatives: Plan 1 2 3 4 Debt 0% 35% 50% 50% Preferred 0% 0% 0% 20% Equity 100% 65% 50% 30% 20% 5 60% 20% The preferred stock carries a 12% dividend rate, and the common stock is priced at $18 per share. Currently, the company has 750,000 shares of common stock outstanding and operates in a 40% tax bracket. a. If the earnings before interest and taxes are $1.5 million, what would be earning per share for five alternatives, assuming no immediate increase in the operating profit. b. Compute the degree of financial leverage (DFL) for each alternatives at the expected EBIT level of $1.5 million.
ABC Investments Inc. is currently managing a capital structure that includes a $3.5 million debt with an interest rate of 12.3%. The company is planning a $5 million expansion initiative and is evaluating five financing alternatives: Plan 1 2 3 4 Debt 0% 35% 50% 50% Preferred 0% 0% 0% 20% Equity 100% 65% 50% 30% 20% 5 60% 20% The preferred stock carries a 12% dividend rate, and the common stock is priced at $18 per share. Currently, the company has 750,000 shares of common stock outstanding and operates in a 40% tax bracket. a. If the earnings before interest and taxes are $1.5 million, what would be earning per share for five alternatives, assuming no immediate increase in the operating profit. b. Compute the degree of financial leverage (DFL) for each alternatives at the expected EBIT level of $1.5 million.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:ABC Investments Inc. is currently managing a capital structure that includes a $3.5 million debt
with an interest rate of 12.3%. The company is planning a $5 million expansion initiative and is
evaluating five financing alternatives:
Plan
1
2
3
4
Debt
0%
35%
50%
50%
Preferred
0%
0%
0%
20%
Equity
100%
65%
50%
30%
20%
5
60%
20%
The preferred stock carries a 12% dividend rate, and the common stock is priced at $18 per
share. Currently, the company has 750,000 shares of common stock outstanding and operates in
a 40% tax bracket.
a. If the earnings before interest and taxes are $1.5 million, what would be earning per share for
five alternatives, assuming no immediate increase in the operating profit.
b. Compute the degree of financial leverage (DFL) for each alternatives at the expected EBIT level
of $1.5 million.
c. Which alternative do you prefer and why?
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