Explore BrainMass
Share

Explore BrainMass

    Expansion consideration for Highland Cable Company

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    Highland Cable Company is considering an expansion of its facilities. Its current income statement is as follows:

    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:

    See attached file for full problem description.

    © BrainMass Inc. brainmass.com October 9, 2019, 7:39 pm ad1c9bdddf
    https://brainmass.com/business/interest-rates/expansion-consideration-for-highland-cable-company-124812

    Attachments

    Solution Preview

    Please see the attached file.

    a)

    Before expansion

    Contribution margin ratio = Sales% - Variable cost % (which is 50% of sales)
    = 100 - 50
    = 50 or 0.50

    Breakeven point (sales dollars) = Total Fixed Cost/Contribution margin ratio
    = 1,500,000/(1 - 0.50)
    = 3,000,000

    After expansion

    Breakeven point (sales dollars) = Total Fixed Cost/Contribution margin ratio
    = 1,900,000/(1 - 0.50)
    = 3,800,000

    b)

    Before expansion

    Degree of operating leverage = Contribution Margin
    Contribution Margin - Fixed Costs

    Degree of operating leverage = 2,000,000/(2,000,000 - 1,500,000)
    = 4

    After expansion

    Degree of operating leverage = 2,500,000/(2,500,000 - 1,900,000)
    = 4.17

    c)

    Before expansion

    Degree of financial leverage = Contribution Margin - Fixed Costs
    (DFL) [Contribution Margin - Fixed Costs - i] - d/(1 - T)

    where,
    i is interest
    d is dividend paid
    T is tax payable
    = 2,000,000 - 1,500,000
    [2,000,000 - 1,500,000 -140,000] - 0/(1 - 0.30)

    = 500,000
    360,000

    = 1.39

    After expansion

    Sell $2 million of debt at 13%. The interest expense is equal to 260,000 plus the original interest expense of 140,000.

    Degree of financial leverage = Contribution Margin - Fixed Costs
    (DFL) [Contribution Margin - Fixed Costs - i] - d/(1 - T)

    where,
    i is interest
    d is dividend paid
    T is tax payable
    = 2,500,000 - 1,900,000
    [2,500,000 - 1,900,000 - 400,000] - 0/(1 - 0.30)

    = 600,000
    200,000

    = 3.00

    After expansion

    Sell $2 million of common stock at $20 per share

    Degree of financial leverage = Contribution Margin - Fixed Costs
    (DFL) [Contribution Margin - Fixed Costs - i] - d/(1 - T)

    where,
    i is interest
    d is dividend paid
    T is tax payable
    = 2,500,000 - 1,900,000
    [2,500,000 - 1,900,000 - 140,000] - 0/(1 - 0.30)

    = 600,000
    460,000

    = 1.30

    After ...

    Solution Summary

    This solution is comprised of a detailed explanation and calculation to consider expansion for Highland Cable Company.

    $2.19