Amarillo Parts is considering purchasing a small firm in the same line of business. The purchase would be financed by either the sale of common stock or by a bond issue. The financial manager wants to evaluate how the two alternative financing plans will affect the earnings potential of the firm. Total financing required is $4.5 million. The firm currently has $20,000,000 of 12 percent bonds and 600,000 common shares outstanding. The firm can arrange financing of the $4.5 million through a 14 percent bond issue or the sale of 100,000 shares of common stock. The firm has a 40 percent tax rate.

(a) What is the degree of financial leverage for each plan at $7,000,000 of EBIT?

(b) What is the financial breakeven point for each plan?