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Indifferent point of EBIT

(The following information relates to Questions 19 to 22)

Firm X with a 40% tax rate is comparing two financing plans. Plan A involves 2,000 shares of common stock and $20,000 of debt. Plan B consists of 2,500 shares of common stock and $10,000 of debt. The annual interest rate is 5%. Presently, this company is all-equity financed and has 3,000 shares outstanding.

19. What is the indifferent point of EBIT between these two plans?
A) $8,000
B) $7,000
C) $6,000
D) $5,000
E) $4,000

20. At the indifference point of EBIT calculated in Question (19), what will be the corresponding earnings per share (EPS)?
A) $0.6
B) $0.8
C) $1.0
D) $1.2
E) $1.4

21. What is the fixed financing cost (i.e. interest payment on debt) that the company has to face under Plan A?
A) $500
B) $750
C) $1,000
D) $1,250
E) Undetermined

22. If the future EBIT is estimated to be $8,000, which plan will this company prefer?
A) Plan A because of its higher EPS
B) Plan B because of its higher EPS
C) Neither plan because of the high leverage
D) Both plans because of their equal EPS

Solution Summary

Solution contains calculations of Indifferent point of EBIT and EPS.