Indifferent point of EBIT
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(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
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Solution contains calculations of Indifferent point of EBIT and EPS.
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