Analyzing Financial Data

    CheckPoint
    Analyzing
    Financial Data

    Resource:Ch. 6 of Understanding Financial Statements
    Complete Problem 6.6 on p. 232 (Ch.
    6).
    Submit your answers to questions A and
    B.

    6.6.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.

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