Question

Edsel Research Labs has $30.60 million in assets. Currently half of these assets are financed with long-term debt at 5 percent and half with common stock having a par value of $10. Ms. Edsel, the Vice President of Finance, wishes to analyze two refinancing plans, one with more debt (D) and one with more equity (E). The company earns a return on assets before interest and taxes of 5 percent. The tax rate is 30 percent. Under Plan D, a $7.65 million long-term bond would be sold at an interest rate of 7 percent and 765,000 shares of stock would be purchased in the market at $10 per share and retired. Under Plan E, 765,000 shares of stock would be sold at $10 per share and the $7,650,000 in proceeds would be used to reduce long-term debt. a-1. How would each of these plans affect earnings per share? Consider the current plan and the two new plans. (Round your answers to 2 decimal places.) Earnings per Share Current Plan D Plan E a-2. Which plan(s) would produce the highest EPS? Note that due to tax loss carry-forwards and carry-backs, taxes can be a negative number. The Current Plan and Plan E O Plan D

Answer 1

	Current Plan	Plan D	Plan E
EBIT	1,530,000	1,530,000	1,530,000
Less: Interest	765,000	1,300,500	382,500
Earnings before tax	765,000	229,500	1,147,500
Less: Tax @30%	229,500	68,850	344,250
Net Income	535,500	160,650	803,250
Number of shares	1,530,000	765,000	2,295,000
EPS	0.35	0.21	0.35
a-2 Current Plan and Plan E