Dorsey Porridge Company presently has $3.6 million in debt outstanding bearing an interest rate of 10 percent. It wishes to finance a $4 million expansion program and is considering three alternatives: additional debt at 12 percent intei-est, preferred stock with an 11 percent dividend, and the sale of common stock at $16 per share. The company presently has 800,000 shares of common stock outstanding and is in a 40 percent tax bracket.

a. If earnings before interest and taxes are presently $1.5 million, what would be earnings per share for the three alternatives, assuming no immediate increase in profitability?

b. Develop an indifference chart for these alternatives. What are the approximate indifference points? To check one of these points, what is the indifference point mathematically between debt and common?

c. Which alternative do you prefer? How much would EBIT need to increase before the next alternative would be best?