ABC Company presently has $3.6 million in debt outstanding, bearing an interest rate of 10 percent. It wishes to finance a $4 million expansion and is considering three alternatives: additional debt at 12% interest; preferred stock with an 11 percent dividend; or the sale of common stock at $16 per share. The company presently has 800,000 shares of 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) What is the indifference/break-even point between debt and common stock?

c) Which alternative would you recommend?

d) How much would EBIT need to increase before the next alternative would be best (i.e., Preferred vs. Debt)?