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    Financing Plan

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    I would like help with Chapter 5, Problem 21 about expansion, break-even analysis, and leverage. The book is Foundations of Financial Management, 11e by Stanley B. Block, Geoffrey A. Hirt Copyrigt 2005 The McGraw-HillCompanies

    Expansion, break-even analysis, and leverage
    Highland Cable Company is considering an expansion of its facilities. Its current income statement is as follows:
    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

    Highland Cable Company is currently financed with 50 percent debt and 50 percent equity (common stock, par value of $10). To expand the facilities, Mr. Highland estimates a need for $2 million in additional financing. His investment banker has laid out three plans for him to consider.
    1. Sell $2 million of debt at 13 percent.
    2. Sell $2 million of common 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 percent of sales, while fixed expenses will incr3ease 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.
    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.
    Mr. Highland is interested in a thorough analysis of his expansion plans and methods of financing. He would like you to analyze the following:
    a. The break-even point for operating expenses before and after expansion (in sales dollars)
    b. The degree of operating leverage before and after expansion. Assume sales of $4 million before expansion and $5 million after expansion. Use the formula in footnote 2.
    c. The degree of financial 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.
    d. Compute EPS under all three methods of financing the expansion at $5 million in sales (first year) and $9 million in sales (last year).
    e. What can we learn from the answer to part d about the advisability of the three methods of financing the expansion?

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    Solution Summary

    The solution explains the calculations required to determine the financing plan to choose for Highland Cable.

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