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 10% 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) |
| Current assets |
$ 900.00 |
|
Notes payable |
$ 255.00 |
| Net fixed assets |
450.00 |
|
Long-term debt (10%) |
700.00 |
|
|
|
Common stock, $3 par |
60.00 |
|
|
|
Retained earnings |
335.00 |
| Total assets |
$1,350.00 |
|
Total liabilities and equity |
$1,350.00 |
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 |
70.00 |
| Earnings before taxes |
$162.50 |
| Federal-plus-state taxes (40%) |
65.00 |
| Net income |
$97.50 |
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. Do not round intermediate calculations. Round your answers to two decimal places. Write out your answer completely. For example, 0.00013 million should be entered as 130.
ANNUAL SALES
(MILLIONS OF DOLLARS) |
|
EPS under
the debt financing |
|
EPS under
the stock financing |
|
|
|
|
|
| $2,250 |
|
$ |
|
$ |
| ???2,700 |
|
$ |
|
$ |
| ???3,150 |
|
$ |
|
$ |
Calculate expected EPS under both debt and stock financing alternatives. Do not round intermediate calculations. Round your answers to two decimal places.
Write out your answer completely. For example, 0.00013 million should be entered as 130.
Under the debt financing expected EPS is $
Under the stock financing expected EPS is $
Calculate sEPS under both debt and stock financing alternatives. Do not round intermediate calculations. Round your answers to two decimal places.
Write out your answer completely. For example, 0.00013 million should be entered as 130.
Under the dept financing sEPS is $
Under the stock financing sEPS is $
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. [Hint: Notes payable should be included in both the numerator and the denominator of the debt-to-capital ratio.] Do not round intermediate calculations. Round your answers to two decimal places.
Under the debt financing:
| The debt ratio is |
% |
| Times-interest-earned ratio is |
|
Under the stock financing:
| The debt ratio is |
% |
| Times-interest-earned ratio is |
|
Which financing method do you recommend?
-Select-DebtEquityItem 15