Question

The Strasburg Company Balance Sheet as of December 31 ($ millions) Current assets $900.00 Accounts payable...

The Strasburg Company
Balance Sheet as of December 31 ($ millions)
Current assets $900.00 Accounts payable $172.50
Net fixed assets 450 Notes payable to bank 255
Other current liabilities 225
Total current liabilities $652.50
Long-term debt (10%) 300
Common stock, $3 par 60
Retained earnings 337.5
Total assets $1,350.00 Total liabilities and equity $1,350.00
Income Statement for Year Ended December 31 ($ millions)
Sales $2,475.00
Operating costs -2,227.50
Earnings before interest and taxes (EBIT) (10%) $247.50
Interest on short-term debt -15
Interest on long-term debt -30
Earnings before taxes (EBT) $202.50
Taxes (40%) -81
Net income $ $121.50
The probability distribution for annual sales is as follows:
Annual Sales
Probability ($ millions)
0.2 $2,250
0.6 2,700
0.2 3,150

Question: What are the implications of these changes?

With P0 = $60 and rd = 12%, change the sales probability distribution to the following:

                                                  Alternative 1                                       Alternative 2       

                                         Sales           Probability                       Sales           Probability

                                        $2,250               0.0                                    $ 0               0.3

                                         2,700               1.0                                2,700               0.4

                                          3,150               0.0                                7,500               0.3

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Homework Answers

Answer #1

Alternative 1: Expected Sales = 2250*0 + 2700*1 + 3150*0 = 2700

EBIT = 10% of 2700 = 270

EBT =270 - Interest = 270 -15 -30 = 225

Taxes = 40% = 0.4*225 = 90

Net Income = 225 -90 = $135

So, net Income increases to $135 in alternative 1

Alternative 2: Expected Sales = 0*0.3 +2700*0.4+7500*0.3 = 3,330

EBIT = 10% of 3330 = 333

EBT =333 - Interest = 333 -15 -30 = 288

Taxes = 40% = 0.4*288 = 115.2

Net Income = 288-115.2 = 172.8

So, net Income increases to $172.8 in alternative 2

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