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    Business Finance Dividends, earnings per share, degree of operating level

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    Sales............................................... $4,000,000
    Less: Variable expense (50% of sales).... 2,000,000
    Fixed expense............................ 1,500,000
    Earnings before interest and taxes (EBIT)... 500,000
    Interest (10% cost).............................. 140,000
    Earnings before taxes (EBT).................. 360,000
    Tax (30%)........................................ 108,000
    Earnings after taxes (EAT).................. $252,000
    Shares of common stock..................... 200,000
    Earnings per share............................. $1.26

    Highland Cable Company is currently financed with 50% debt and 50% equity (common stock, par value of $10). To expand the facilities Mr. Highland estimates a need for $2 million in additional financing. His investment broker has laid out three plans for him to consider:

    1. Sell $3 million of debt at 13%
    2. Sell $2 million of commons stock at $20 per share.
    3. Sell $1 million of debt at 12% and $1 million of common stock at $25 per share.

    Variable costs are expected to stay at 50% of sales, while fixed expenses will increase to $1,900,000 per year. Mr. Highland is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1 million per year for the next five years.

    A. The degree of operating leverage before expansion at sales of $4 million and for all three methods of financing after expansion. Assume sales of $5 million for the second part of this question.

    B. Compute EPS under all three methods of financing the expansion at $5 million in sales (first year) and $9 million in sales (last year).

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    Solution Summary

    Sales............................................... $4,000,000
    Less: Variable expense (50% of sales).... 2,000,000
    Fixed expense............................ 1,500,000
    Earnings before interest and taxes (EBIT)... 500,000
    Interest (10% cost).............................. 140,000
    Earnings before taxes (EBT).................. 360,000
    Tax (30%)........................................ 108,000
    Earnings after taxes (EAT).................. $252,000
    Shares of common stock..................... 200,000
    Earnings per share............................. $1.26

    Highland Cable Company is currently financed with 50% debt and 50% equity (common stock, par value of $10). To expand the facilities Mr. Highland estimates a need for $2 million in additional financing. His investment broker has laid out three plans for him to consider:

    1. Sell $3 million of debt at 13%
    2. Sell $2 million of commons stock at $20 per share.
    3. Sell $1 million of debt at 12% and $1 million of common stock at $25 per share.

    Variable costs are expected to stay at 50% of sales, while fixed expenses will increase to $1,900,000 per year. Mr. Highland is not sure how much this expansion will add to sales, but he estimates that sales will rise by $1 million per year for the next five years.

    A. The degree of operating leverage before expansion at sales of $4 million and for all three methods of financing after expansion. Assume sales of $5 million for the second part of this question.

    B. Compute EPS under all three methods of financing the expansion at $5 million in sales (first year) and $9 million in sales (last year).

    $2.19