Answer:
Dickinson Company
a) Effect of each plan on earnings per share:
Current Plan Plan D Plan E
Earnings per share $0.45 $0.36 $0.45
b-1) Earnings per share $0 $0 $0.14
b-2. Plan E would be most favorable if return on assets fell to 4.70%.
b-3 Earnings per share $0.93 $0.70 $0.76
b-4 Current Plan would be most favorable if return on assets increased to 14.4%.
c-1 Earnings per share $0.45 $0.36 $0.45
c-2 If the market price for common stock rose to $12 before the restructuring, Plan E would then be most attractive to the company as it would get additional paid-in capital of $1,485,000 ($4 * 371,250).
Explanation:
a) Data and Calculations:
Return on assets before interest and taxes = 9.4%
Tax rate = 40%
Current Plan Plan D Plan E
Assets $11,880,000 $11,880,000 $11,800,000
Long-term debt 5,940,000 5,940,000 2,970,000
New debt 2,970,000
Total debt 8,910,000
Common stock 5,940,000 5,940,000 8,910,000
Less repurchased shares (2,970,000)
New common stock 2,970,000
Interest rate of old debt 9.4% 9.4% 9.4%
Interest rate for new debt 11.4%
Stock par value $8 $8 $8
Return on assets before
interest and taxes $1,116,720 $1,116,720 $1,116,720
Interest expense 558,360 896,940 298,180
Return before taxes $558,360 $219,780 $837,540
Tax rate = 40% 223,344 87,912 335,016
Return after taxes $335,016 $131,868 $502,524
Shares outstanding 742,500 371,250 1,113,750
Earnings per share $0.45 $0.36 $0.45
Return on assets falling to 4.70%
Return on assets before
interest and taxes $558,360 $558,360 $558,360
Interest expense 558,360 896,940 298,180
Return before taxes $0 -$338,580 $260,180
Tax rate = 40% 0 0 104,072
Return after taxes $0 $0 $156,108
Shares outstanding 742,500 371,250 1,113,750
Earnings per share $0 $0 $0.14
Return on assets increasing to 14.4%:
Return on assets before
interest and taxes $1,710,720 $1,710,720 $1,710,720
Interest expense 558,360 896,940 298,180
Return before taxes $1,152,360 $431,380 $1,412,540
Tax rate = 40% 460,944 172,552 565,016
Return after taxes $691,416 $258,828 $847,524
Shares outstanding 742,500 371,250 1,113,750
Earnings per share $0.93 $0.70 $0.76
Market price for common stock rose to $12 before restructuring:
Return on assets before
interest and taxes $1,116,720 $1,116,720 $1,116,720
Interest expense 558,360 896,940 298,180
Return before taxes $558,360 $219,780 $837,540
Tax rate = 40% 223,344 87,912 335,016
Return after taxes $335,016 $131,868 $502,524
Shares outstanding 742,500 371,250 1,113,750
Earnings per share $0.45 $0.36 $0.45
