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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937
Textbook Problem
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FINANCING ALTERNATIVES The Severn Company plans to raise a net amount of $270 million to finance new equipment in early 2017. Two alternatives are being considered: Common stock may be sold to net $60 per share, or bonds yielding 12% may be issued. The balance sheet and income statement of the Severn Company prior to financing are as follows:

The Severn Company: Balance Sheet as of December 31, 2016 (Millions of Dollars)

Chapter 13, Problem 13P, FINANCING ALTERNATIVES The Severn Company plans to raise a net amount of 270 million to finance new

The Severn Company: Income Statement for Year Ended December 31, 2016 (Millions of Dollars)

Sales $2,475.00
Operating costs 2,227.50
Earnings before interest and taxes (10%) $ 247.50
Interest on short-term debt 15.00
Interest on long-term debt 69.75
Earnings before taxes $ 162.75
Federal-plus-state taxes (40%) 65.10
Net income $ 97.65

The probability distribution for annual sales is as follows:

The probability distribution for annual sales is as follows:

Probability Annual Sales (Millions of Dollars)
0.30 $2,250
0.40 2,700
0.30 3,150

Assuming that EBIT equals 10% of sales, calculate earnings per share (EPS) under the debt financing and the stock financing alternatives at each possible sales level. Then calculate expected EPS and σeps under both debt and stock financing alternatives. Also calculate the debt-to-capital ratio and the times-interest-earned (TIE) ratio at the expected sales level under each alternative. The old debt will remain outstanding. Which financing method do you recommend? (Hint: Notes payable should be included in both the numerator and the denominator of the debt-to-capital ratio.]

Summary Introduction

To determine: EPS under debt and equity financing, debt to capital ratio and time interest earned ratio.

Introduction:

Earnings per share (EPS):

Earnings per share are the portion of profit that distributed among the shareholders of the company. Earnings per share can be obtained by dividing earnings available to equity shareholder and the number of outstanding share.

Explanation

Statement that shows the calculation of EPS, debt to capital ratio and time interest earned ratio.

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