Question
Abby Corporation manufactures PC printers and is planning to expand its business due to increased sales in recent years. As a result, the firm is
Abby Corporation manufactures PC printers and is planning to expand its business due to increased sales in recent years. As a result, the firm is considering three different financing plans to raise $240,000 for a new automatic production line. The financing plans are shown as follows:
Three different financing plans
Plan I Common stock: $240,000 Plan II Bonds at 4%: $80,000 & Common stock: $160,000 Plan III Preferred stock at 4%: $80,000 & Common stock: $160,000
The financial analyst of the firms relationship bank advises that the common stock could be sold at the current market price of $40 per share for all three plans. The corporate tax rate is 40%.
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a Determine the EBIT indifference levels between the financing plans. (9 marks)
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b The new production line is expected to generate an EBIT of $20,000 per year. Which plan would the firm choose for the highest EPS?
(8 marks)
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c Determine the EBIT level that will make Plan I, II and IIIs EPS = $0 and draw the EBIT-EPS analysis chart. (8 marks)
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d What are the primary weaknesses of EBIT-EPS analysis? (5 marks)
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