Case: LEVERAGE
Cook Corporation issued financial statements at December 31, 2008, that include the following information:
Balance sheet at December 31, 2008:
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Assets
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$8,000,000
|
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Liabilities
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1,200,000
|
|
Stockholders' equity (300,000 shares)
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6,800,000
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Income statement for 2008:
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Income from operations
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$1,200,000
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|
Less: Interest expense
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100,000
|
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Income before taxes
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$1,100,000
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Less: Income taxes expense (0.30)
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330,000
|
|
Net income
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$ 770,000
|
The levels of assets, liabilities, stockholders' equity, and operating income have been stable in recent years; however, Cook Corporation is planning a $1,800, 000 expansion program that will increase income from operations by $350,000 to $1,550,000. Cook is planning to sell 8.5 percent notes at par to finance the expansion.
Required:
1. What earnings per share does Cook report before the expansion?
2. What earnings per share will Cook report if the proposed expansion is undertaken? Would this use of leverage be advantageous to Cook's stockholders? Explain.
3. Suppose income from operations will increase by only $150,000. Would this use of leverage be advantageous to Cook's stockholders? Explain.
4. Suppose that income from operations will increase by $200,000 and that Cook could also raise the required $1,800,000 by issuing an additional 100,000 shares of capital stock. Which means of financing would stockholders prefer? Explain.