Reference no: EM13483111

Phelps Canning Company is considering an expansion its current income staement is Sales $5,000,000;Variable Expenses(50% of sales)$2,500,000;Fixed Expenses $1,800,000;EBIT $700,000; interest(10% cost)$200,000;ebt $500,000;Taxes (34%)$170,000; EAT $300,000; Shares of Common Stock 200,000; EPS $1.65

Phelps is currently financed with 50% debt and 50% equity(common stock). To expand facilitites Phelps estimates a need for $2 million in additional financing. His investment dealer has laid out 3 plans for him to consider.

1: Sell $2million of debt at 13% ,2. Sell $2million of common stock at $20 per share, 3. Sell $1million of debt at 12% and $1million of common stock at $25 per share.

Variable costs are expected to stay at 50% of sales,while fixed expenses will increase to $2,300,000 per year. Phelps is not sure how much this expansion will add to sales, but he estimates sales will rise $1million per year for 5 years. Determine

a)Break even point for operating expenses before and after expansion(in sales dollars)

b)Degree of operating leverage before and after expansion assuming sales of $5million before expansion and $6million after expansion.

c)Degree of financial leverage before expansion at sales of $5million and for all three methods of financing after expansion. Assume sales of $6million for the second part of this question.

d)Compute EPS under all three methods of financing the expansion at $6million in sales (first year)and $10million in sales (last year).

e)What can we learn from the answer to part d about the advisability of the three methods of financing the expansion? Make your selection of the financing method that best suits Phelps objective of maximizing shareholders wealth.