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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).

#### 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