Dickinson Company has $11,880,000 million in assets. Currently half of these assets are financed with long-term debt at 9.4 percent and half with common stock having a par value of $8. Ms. Smith, Vice-President of Finance, wishes to analyze two refinancing plans, one with more debt (D) and one with more equity (E). The company earns a return on assets before interest and taxes of 9.4 percent. The tax rate is 40 percent. Tax loss carryover provisions apply, so negative tax amounts are permissable.
Under Plan D, a $2,970,000 million long-term bond would be sold at an interest rate of 11.4 percent and 371,250 shares of stock would be purchased in the market at $8 per share and retired.
Under Plan E, 371,250 shares of stock would be sold at $8 per share and the $2,970,000 in proceedswould be used to reduce long-term debt.
a. How would each of these plans affect earnings per share? Consider the current plan and the two new plans. (Round your answers to 2 decimal places.)
Current Plan Plan D Plan E
Earnings per share $ $ $
b-1. Compute the earnings per share if return on assets fell to 4.70 percent. (Leave no cells blank - be certain to enter "0" wherever required. Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.)
Current Plan Plan D Plan E
Earnings per share $ $ $
b-2. Which plan would be most favorable if return on assets fell to 4.70 percent? Consider the current plan and the two new plans.
Current Plan
Plan E
Plan D
b-3. Compute the earnings per share if return on assets increased to 14.4 percent. (Round your answers to 2 decimal places.)
Current Plan Plan D Plan E
Earnings per share $ $ $
b-4. Which plan would be most favorable if return on assets increased to 14.4 percent? Consider the current plan and the two new plans.
Current Plan
Plan E
Plan D
c-1. If the market price for common stock rose to $12 before the restructuring, compute the earnings per share. Continue to assume that $2,970,000 million in debt will be used to retire stock in Plan D and $2,970,000 million of new equity will be sold to retire debt in Plan E. Also assume that return on assets is 9.4 percent. (Round your answers to 2 decimal places.)
Current Plan Plan D Plan E
Earnings per share $ $ $
c-2. If the market price for common stock rose to $12 before the restructuring, which plan would then be most attractive?
Current Plan
Plan D
Plan E

c-2 If the market price for common stock rose to $12 before the restructuring, Plan E would then be most attractive to the company as it would get additional paid-in capital of $1,485,000 ($4 * 371,250).

Explanation:

a) Data and Calculations:

Return on assets before interest and taxes = 9.4%

Tax rate = 40%

Current Plan Plan D Plan E

Assets $11,880,000 $11,880,000 $11,800,000

Long-term debt 5,940,000 5,940,000 2,970,000

New debt 2,970,000

Total debt 8,910,000

Common stock 5,940,000 5,940,000 8,910,000

Less repurchased shares (2,970,000)

New common stock 2,970,000

Interest rate of old debt 9.4% 9.4% 9.4%

Interest rate for new debt 11.4%

Stock par value $8 $8 $8

Return on assets before

interest and taxes $1,116,720 $1,116,720 $1,116,720

Interest expense 558,360 896,940 298,180

Return before taxes $558,360 $219,780 $837,540

Tax rate = 40% 223,344 87,912 335,016

Return after taxes $335,016 $131,868 $502,524

Shares outstanding 742,500 371,250 1,113,750

Earnings per share $0.45 $0.36 $0.45

Return on assets falling to 4.70%

Return on assets before

interest and taxes $558,360 $558,360 $558,360

Interest expense 558,360 896,940 298,180

Return before taxes $0 -$338,580 $260,180

Tax rate = 40% 0 0 104,072

Return after taxes $0 $0 $156,108

Shares outstanding 742,500 371,250 1,113,750

Earnings per share $0 $0 $0.14

Return on assets increasing to 14.4%:

Return on assets before

interest and taxes $1,710,720 $1,710,720 $1,710,720

Interest expense 558,360 896,940 298,180

Return before taxes $1,152,360 $431,380 $1,412,540

Tax rate = 40% 460,944 172,552 565,016

Return after taxes $691,416 $258,828 $847,524

Shares outstanding 742,500 371,250 1,113,750

Earnings per share $0.93 $0.70 $0.76

Market price for common stock rose to $12 before restructuring:

Return on assets before

interest and taxes $1,116,720 $1,116,720 $1,116,720

Interest expense 558,360 896,940 298,180

Return before taxes $558,360 $219,780 $837,540

Tax rate = 40% 223,344 87,912 335,016

Return after taxes $335,016 $131,868 $502,524

Shares outstanding 742,500 371,250 1,113,750

Earnings per share $0.45 $0.36 $0.45