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October 21, 2014

Homework Help: Finance

Posted by Raana on Sunday, April 5, 2009 at 12:00pm.

The Norman Automatic mailer Machine Company is planning to expand production. The expansion will cost $2000,000, which can either be financed by bonds at an interest rate of 12 percent or by selling 40,000 shares of common stock at $50 per share. The current income statement before expansion is as follows:

Norman Automatic Mailer

Income Statement



Sales $3000,000

Variable Costs (40%) 1,200,000

Contribution margin 1,800,000

Fixed Costs 800,000

earnings before interest and taxes 1000,000

interest expense 400,000

Earnings beofre tax 600,000

taxes @ 34% 204,000

earnings after tax $396,000



Shares 100,000

earnings per share $3.96



After the expansion sales are expected to increase by 1,500,000. Variable Costs will remain at 40 percent of sales, and fixed costs will increase to $550,000. The tax rate is 34 percent.

a) construct the income statement for the two financial plans.

b) calculate the degree of operating leverage, the degree of financial leverage, and the degree of combined leverage, after expansion for the two financing plans

c) calculate the ebit/eps indifference point.

d) explain which plan you favor and the risks involved.



formulas: DOL= CM/EBIT



DFL=EBIT/EBT



DCL= DOL * DFL



indifference point= (S(B) * I(A)- S(A) * I(B) / S(B) - S(A)

I is interet costs under plan A and B

S is shares Outstanding under plan A and B

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