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Question
Balon Plastics, Inc. is financed entirely with 3 million shares of common stock selling for $20 a share. Capital of $4 million is needed for this year's capital budget. Additional funds can be raised with new stock (ignore dilution) or with 13 percent 10-year bonds. The firm's tax rate is 40 percent.a. Calculate the financing plan's EBIT indifference point.
b. The expected level of EBIT is $10,320,000 with a standard deviation of $2,000,000. What is the probability that EBIT will be above the indifference point?
c. Does the "indifference point" calculated in question (a) above truly represent a point where stockholders are indifferent between stock and debt financing? Explain your answer.
Answer
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