Wingler Communications Corporation (WCC) producespremium stereo headphones that sell for $28.80 per set, and this year’s sales are expectedto be 450,000 units. Variable production costs for the expected sales under present productionmethods are estimated at $10,200,000, and fixed production (operating) costs at presentare $1,560,000. WCC has $4,800,000 of debt outstanding at an interest rate of 8%. There are240,000 shares of common stock outstanding, and there is no preferred stock. The dividendpayout ratio is 70%, and WCC is in the 40% federal-plus-state tax bracket.The company is considering investing $7,200,000 in new equipment. Sales would notincrease, but variable costs per unit would decline by 20%. Also, fixed operating costswould increase from $1,560,000 to $1,800,000. WCC could raise the required capital byborrowing $7,200,000 at 10% or by selling 240,000 additional shares of common stock at$30 per share.a. What would be WCC’s EPS (1) under the old production process, (2) under the newprocess if it uses debt, and (3) under the new process if it uses common stock?b. At what unit sales level would WCC have the same EPS assuming it undertakes theinvestment and finances it with debt or with stock? {Hint: V = variable cost per unit = $8,160,000/450,000, and EPS = [(PQ – VQ – F – I)(1 – T)]/N. Set EPSStock = EPSDebt and solve for Q.}c. At what unit sales level would EPS = 0 under the three production/financing setups—that is, under the old plan, the new plan with debt financing, and the new plan withstock financing? (Hint: Note that Vold = $10,200,000/450,000, and use the hints for partb, setting the EPS equation equal to zero.)d. On the basis of the analysis in parts a through c, and given that operating leverage islower under the new setup, which plan is the riskiest, which has the highest expectedEPS, and which would you recommend? Assume that there is a fairly high probabilityof sales falling as low as 250,000 units. Determine EPSDebt and EPSStock at that sales levelto help assess the riskiness of the two financing plans.
Wingler Communications Corporation (WCC) produces
premium stereo headphones that sell for $28.80 per set, and this year’s sales are expected
to be 450,000 units. Variable production costs for the expected sales under present production
methods are estimated at $10,200,000, and fixed production (operating) costs at present
are $1,560,000. WCC has $4,800,000 of debt outstanding at an interest rate of 8%. There are
240,000 shares of common stock outstanding, and there is no
payout ratio is 70%, and WCC is in the 40% federal-plus-state tax bracket.
The company is considering investing $7,200,000 in new equipment. Sales would not
increase, but variable costs per unit would decline by 20%. Also, fixed operating costs
would increase from $1,560,000 to $1,800,000. WCC could raise the required capital by
borrowing $7,200,000 at 10% or by selling 240,000 additional shares of common stock at
$30 per share.
a. What would be WCC’s EPS (1) under the old production process, (2) under the new
process if it uses debt, and (3) under the new process if it uses common stock?
b. At what unit sales level would WCC have the same EPS assuming it undertakes the
investment and finances it with debt or with stock? {Hint: V = variable cost per unit = $8,160,000/450,000, and EPS = [(PQ – VQ – F – I)(1 – T)]/N. Set EPSStock = EPSDebt and solve for Q.}
c. At what unit sales level would EPS = 0 under the three production/financing setups—
that is, under the old plan, the new plan with debt financing, and the new plan with
stock financing? (Hint: Note that Vold = $10,200,000/450,000, and use the hints for part
b, setting the EPS equation equal to zero.)
d. On the basis of the analysis in parts a through c, and given that operating leverage is
lower under the new setup, which plan is the riskiest, which has the highest expected
EPS, and which would you recommend? Assume that there is a fairly high probability
of sales falling as low as 250,000 units. Determine EPSDebt and EPSStock at that sales level
to help assess the riskiness of the two financing plans.
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