1. (Adjusting a firm's capital structure) Curley's Fried Chicken Kitchen operates two southern cooking restaurants in St. Louis, Missouri, and has the following financial structure:
Accounts Payable-$109,000
Short Term Debt-$393,000
Current Liabilities-$502,000
Long-Term Debt-$2,017,000
Owner's Equity-$1,559,000
Total-$4,078,000
The firm is considering an expansion that would involve raising an additional $2.5 million.
a. What are the firm's debt ratio AND interest-bearing debt ratio in its present capital structure?
b. If the firm wants to have a debt ratio of 50%, how much equity does the firm need to raise in order to finance the expansion?
2. (Leverage and EPS) You have developed the following pro forma income statement for your corporation:
Sales-$45,748,000
Variable Costs-($22,807,000)
Revenue before fixed costs-$22,941,000
Fixed Costs-($9,244,000)
EBIT-$13,697,000
Interest Expense-($1,447,000)
Earnings Before Taxes-$12,250,000
Taxes (50%)-($6,125,000)
Net Income-$6,125,000
It represents the most recent year's operations, which ended yesterday. Your supervisior in the controller's office has just handed you a memorandum asking for written responses to the following questions:
a. If sales should increase by 25%, by what percent would earnings before interest and taxes and net income increase?
b. If sales should decrease by 25%, by what percent would earnings before interest and taxes and net income decrease?
c. If the firm were to reduce its reliance on debt financing such that interest expense were cut in half, how would this affect your answers to part a and b?
3. (EBIT-EPS analysis) Abe Forrester and three of his friends from college have interested a group of venture capitalists in backing their business idea. The proposed operation would consist of a series of retail outlets to distribute and service a full line of vacuum cleaners and accessories. These stores would be located in Dallas, Houston, and San Antonio. To finance the new venture two plans have been proposed:
Plan A is an all-common-equity structure in which $2.1 million dollars would be rasied by selling 86,000 shares of common stocks.
Plan B would involve issuing $1.3 million in long-term bonds with an effective interest rate of 12.1 percent plus another $0.8 million would be raised by selling 43,000 shares of common stock. The debt funds raised under Plan B have no fixed maturity date, in that this amount of financial leverage is considered a permanent part of the firm's capital structure.
Abe and his partners plan to use a 38 percent tax rate in their analysis, and they have hired you on a consulting basic to do the following:
a. Find the EBIT indifference level associated with the two financing plans.
b. Prepare a pro forma income statement for the EBIT level solved for in part a that shows that EPS will be the same regardless whether Plan A or B is chosen.