# Problem 5-24 Leverage and sensitivity analysis (LO5-6] Edsel Research Labs has \$29.40 million in assets. Currently...

Problem 5-24 Leverage and sensitivity analysis (LO5-6] Edsel Research Labs has \$29.40 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 \$7.35 million long-term bond would be sold at an interest rate of 11 percent and 735,000 shares of stock would be purchased in the market at \$10 per share and retired. Under Plan E, 735,000 shares of stock would be sold at \$10 per share and the \$7,350,000 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. O The Current Plan and Plan E O Plan D O Plan E O Current Plan

a -1

 Earnings per share Current 0.46 Plan D 0.29 Plan E 0.46

Workings

Note. In Plan D and Plan E fresh shares issued are assumed as common stock ( Equity) shares.

 Computaion of EPS Current Plan D Plan E Earnings before Interest & taxes ( GIVEN 5 % return on assets) 1470000 1470000 1470000 Less Interest 735000 808500 367500 Earnings before taxes 735000 661500 1102500 Less Tax @ 5% 36750 33075 55125 Net profit 698250 628425 1047375 EPS = Net profit/Number of common stock shares Number of shares 1470000 2205000 2205000 EPS 0.475 0.285 0.475 EPS ( Rounded to two decimals ) 0.46 0.29 0.46
 Combinations of Finances In millon In millon In millon Current Plan D Plan E Common stock @ 10/share 14700000 14.7 Common stock @ 10/share 14700000 14.7 Common stock @ 10/share 14700000 14.7 Long term debt @ 5% 14700000 14.7 Long term bond @ 11% 7350000 7.35 New shares( common atock) 7350000 7.35 New shares( common atock) 7350000 7.35 Long ter debt @ 5% ( 14700000 - Proceedigs from issue of shares 735000 0 7350000 7.35 Total 29400000 29.4 29400000 29.4 29400000 29.4 Retun on assets ( 29.4 X 5%) 1470000 1.47 Retun on assets ( 29.4 X 5%) 1470000 1.47 Retun on assets ( 29.4 X 5%) 1470000 1.47 Interset expenses 735000 0.735 Interset expenses 808500 0.8085 Interset expenses 367500 0.3675 ( 14700000 x 5%) ( 7350000 X 11% ) ( 7350000 X 5 % ) Number of common stock shrares 1470000 Number of common stock shrares 2205000 Number of common stock shrares 2205000

a - 2

The current plan and plan E would produce higest EPS (0.46 ) compared to plan D ( 0.29 )

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