2. Andover Industries is trying to find the capital structure that maximizes its earnings per share. It needs to raise one million dollars for expansion and is considering the following two mutually exclusive alternatives:

Option Debt Preferred Stock Common Stock

1 $200,000 $200,000 $600,000

2 $500,000 $100,000 $400,000

If the expected value of EBIT next year is $750,000, which plan would maximize earnings per share, given the following information about the firm?

Market Value of the Original Firm Before Expansion = $5,000,000

Market Value of Original Common Stock Before Expansion = $3,000,000

Market Value of Original Debt Before Expansion = $2,000,000

Before Tax Cost of Debt = 6%

Cost of Preferred Stock = 8%

Price per Share of Common Stock = $100

Corporate Tax Rate = 30%