Glen Mount Furniture Company Case 3
Financial Leverage
Purpose: The potential impact of changes in the debt level on earnings per share is the central focus of
the case. However, the instructor can derive educational benefits that go well beyond this point. The
central figure in the case is frustrated by security analyst’s short-term emphasis on earnings per share and
their lack of concern for the long-term fundamentals associated with his firm. This rather common
situation can be drawn upon to make for a more dynamic discussion process. The student is given ample
opportunities to calculate EPS under different financial leverage strategies and to examine debt ratios, and
degrees of leverage.
Relation to Text: The case should follow Chapter 5. Because the case has some elementary valuation
considerations as well, it also could be used later in the course.
Complexity: The case is moderately complex. It should require 1 hour.
Solutions
1. Sales ($45,500,000 + $500,000…………………………………………….. $45,500,000
Interest ……………………………………………………………………………… 1,275,000
2. Earnings per share, 2016…………………………………………. $1.63
3. Sales…………………………………………………………………………………….$45,500,000
Fixed costs ……………………………………………………………………….. 12,900,000
Variable costs (58% of sales) ……………………………………………… 26,390,000
Operating income (EBIT)………………………………………………………. 6,210,000
Interest* ……………………………………………………………………………. 2,400,000
*Interest
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of McGraw-Hill Education.
4. Earnings per share, 2016 (based on more debt)………………………. $1.83
Earnings per share, 2015………………………………………………………. 1.56
%3.17
56.1$
27$.
2010share,perEarnings
Increase
26.1
000,935,4$
000,210,6$
000,275,1$000,210,6$
000,210,6$
I-EBIT
EBIT
(1) DFL.5
63.1
000,810,3$
000,210,6$
000,4 00,2$000,210,6$
000,210,6$
IEBIT
EBIT
(3)DFL
87.3
000,935,4$
000,110,19$
000,275,1$000,900,12$000,390,26$000,500,45$
000,390,26$000,500,4 5$
IFCTVCS
TVCS
(1)DCL6.
02.5
000,810,3$
000,110,19$
000,400,2$000,900,12$000,390,26$000,500,45$
000,390,26$000,500,45$
IFCTVCS
TVCS
(3)DCL
7. From Figure 2:
%2.43
000,500,4 0$
000,500,17$
assetsTotal
debtTotal
After new debt issue:
%9.67
000,500,40$
000,500,27$
000,500,40$
000,000,10$000,500,17$
assetsTotal
debtTotal
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of McGraw-Hill Education.
8. There are two conflicting factors that could influence the stock price.
On the positive side, earnings per share would be twenty cents higher with more debt ($1.83 versus
$1.63).
Based on a current price-earnings ratio of about 10 (the repurchase price for the shares is for $16
Two dollars represents a healthy 12.5% increase from the current value of $16 per share. However,
The net effect of the increase in earnings per share versus the likely decrease in the price-earnings
ratio can only be conjectured. Security analysts following Glen Mount Furniture Company seem to
One clue to the eventual reaction of the market to the recapitalization might lie in the data on the debt
ratios of other firms in the industry. If 67.9% is perceived to be on the high end, there might be little
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.