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Question
Balon Plastics, Inc. is trying to decide how best to finance a proposed $10,000,000 capital investment. Under Plan I, the project will be financed entirely with long-term 9 percent bonds. The firm currently has no debt or preferred stock. Under Plan II, common stock will be sold to net the firm $20 a share; presently, 1,000,000 shares are outstanding. The corporate tax rate for Balon is 40 percent.a. Calculate the indifference level of EBIT associated with the two financing plans.
b. Prepare an EBIT-EPS analysis chart, showing the intersection of the two financing plan lines.
c. Which financing plan would you expect to cause the greatest change in EPS relative to a change in EBIT? Why?
d. If EBIT is expected to be $3.1 million, which plan will result in a higher EPS?
Answer
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