The Severn Company: Balance Sheet as of December 31, 2018 (millions of dollars) Current assets $ 900.00 Notes payable $ 255.00 Net fixed assets 450.00 Long-term debt (10%) 697.50 Common stock, $3 par 60.00 Retained earnings 33750 Total assets $1350.00 Total liabilities and equity $1350.00 The Severn Company: Income Statement for Year Ended December 31, 2018 (millons 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 69.75 Earnings before taxes $ 162.75 Federal-plus-state taxes (40%) 65.10 Net income $ 97.65 The probability distribution for annual sales is as follows: Annual Sales (millions of Probability dollars) 0.30 $2,250 0.40 2,700 0.30 3,150

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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The Severn Company plans to raise a net amount of
$270 million to finance new equipment in early 2019. Two alternatives are being considered:
Common stock may be sold to net $60 per share, or bonds yielding 12% may be issued.
The balance sheet and income statement of the Severn Company prior to financing are as
follows:

 

 

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. Then calculate
expected EPS and σEPS under both debt and stock financing alternatives. Also 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. Which financing method do
you recommend? (Hint: Notes payable should be included in both the numerator and the
denominator of the debt-to-capital ratio.)

The Severn Company: Balance Sheet as of December 31, 2018
(millions of dollars)
Current assets
$ 900.00 Notes payable
$ 255.00
Net fixed assets
450.00 Long-term debt (10%)
697.50
Common stock, $3 par
60.00
Retained earnings
33750
Total assets
$1350.00 Total liabilities and equity $1350.00
The Severn Company: Income Statement for Year Ended
December 31, 2018 (millons 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
69.75
Earnings before taxes
$ 162.75
Federal-plus-state taxes (40%)
65.10
Net income
$ 97.65
The probability distribution for annual sales is as follows:
Annual Sales
(millions of
Probability
dollars)
0.30
$2,250
0.40
2,700
0.30
3,150
Transcribed Image Text:The Severn Company: Balance Sheet as of December 31, 2018 (millions of dollars) Current assets $ 900.00 Notes payable $ 255.00 Net fixed assets 450.00 Long-term debt (10%) 697.50 Common stock, $3 par 60.00 Retained earnings 33750 Total assets $1350.00 Total liabilities and equity $1350.00 The Severn Company: Income Statement for Year Ended December 31, 2018 (millons 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 69.75 Earnings before taxes $ 162.75 Federal-plus-state taxes (40%) 65.10 Net income $ 97.65 The probability distribution for annual sales is as follows: Annual Sales (millions of Probability dollars) 0.30 $2,250 0.40 2,700 0.30 3,150
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