Laurel Street Debt Ratio, Time Interest Earned...?

Laurel Street, president of Uvalde Manufacturing Inc. is preparing a proposal to present to her board of directors regarding a planned plant expansion that will cost $10 million. At issue is whether the expansion should be financed with debt (a long-term note at First National Bank of Uvalde with an interest rate of 15%) or through the issuance of common stock (200,000 shares at $50 per share). Uvalde Manufacturing currently has a capital structure of: Debt (12% interest) 40,000,000 Equity 50,000,000 The firm’s most recent income statement is presented next: Sales $100,000,000 Cost of goods sold 65,000,000 Gross profit 35,000,000 Operating expenses 20,000,000 Operating profit 15,000,000 Interest expense 4,800,000 Earnings before tax 10,200,000 Income tax expense (40%) 4,080,000 Net income $ 6,120,000 Earnings per share (800,000 shares) $ 7.65 Laurel Street is aware that financing the expansion with debt will increase risk but could also benefit shareholders through financial leverage. Estimates are that the plant expansion will increase operating profit by 20%.The tax rate is expected to stay at 40%.Assume a 100% dividend payout ratio. Required a. Calculate the debt ratio, time interest earned, earnings per share, and the financial leverage index under each alternative, assuming the expected increase in operating profit is realized. b. Discuss the factors the board should consider in making a decision.

6 months ago - 1 answers