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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

BREAKEVEN AND LEVERAGE Wingler Communications Corporation (WCC) produces premium stereo headphones that sell for $28 80 per set, and this year’s sales are expected to be 450,000 units. Variable production costs for the expected sales under present production methods are estimated at $10,200,000, and fixed production (operating) costs at present are $1,560,000. WCC has $4,800,000 of debt outstanding at an interest rate of 8%. There are 240,000 shares of common stock outstanding, and there is no preferred stock. The dividend payout ratio is 70%, and WCC is in the 40% federal-plus-state tax bracket.

The company is considering investing $7,200,000 in new equipment. Sales would not increase, but variable costs per unit would decline by 20%. Also, fixed operating costs would increase from $1,560,000 to $1,800,000. WCC could raise the required capital by borrowing $7,200,000 at 10% or by selling 240,000 additional shares of common stock at $30 per share.

  1. a. What would be WCC’s EPS (1) under the old production process, (2) under the new process if it uses debt, and (3) under the new process if it uses common stock?
  2. b. At what unit sales level would WCC have the same EPS assuming it undertakes the investment and finances it with debt or with stock? {Hint: V = variable cost per unit $8,160,000 450,000, and EPS =[(PQ – VQ – F – I) (1 – T)]/N. Set EPSStock = EPSDebt and solve for Q.}
  3. c. At what unit sales level would EPS 0 under the three production/financing setups— that is, under the old plan, the new plan with debt financing, and the new plan with stock financing?(Hint: Note that Vold $10,200,000 450,000, and use the hints for part b, setting the EPS equation equal to zero.)
  4. d. On the basis of the analysis in parts a through c, and given that operating leverage is lower under the new setup, which plan is the riskiest, which has the highest expected EPS, and which would you recommend? Assume that there is a fairly high probability of sales falling as low as 250,000 units. Determine EPSDebt and EPSStock at that sales level to help assess the riskiness of the two financing plans.

a.(1)

Summary Introduction

To determine: The earnings per share using the old production process.

Introduction:

Earnings Per Share (EPS):

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

Break-even analysis:

Break-even analysis is a type of tool used by the cost accountant professionals to find out the number of unit produced when the total cost is equal to the company revenue.

Explanation

Statement that shows earning per share

(2)

Summary Introduction

To determine: The Earnings Per Share under the new production process if W Company uses debt.

(3)

Summary Introduction

To determine: The Earnings Per Share under the new production process if W Company issues common stock.

b.

Summary Introduction

To determine: The sales unit if W Company has same EPS assuming that investment finance with debt or with equity.

c.

Summary Introduction

To determine: The sales unit when the EPS is zero.

d.

Summary Introduction

To determine: The riskiest plan as debt financing or stock financing, determine EPS at 250,000 sales units.

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