FINA3361 A3

Page

2

Problem

#

4 (16 marks)

Harden Hardwar

e Limited

is considering

a change to its current capital structure.

The current

capital structure

(Plan

I

)

is

all equity with 210,000 common shares

outstanding.

Under

Plan II

,

the company would issue debt to

buy back shares

, leaving

150,000 shares of common stock

outstanding and

$2,280,000

in debt at an interest rate of 8%. The tax rate is 40%

a)

If EBIT is $500,000, Which plan will result in the highest EPS

?

Show your work

.

(4 marks)

b)

If EBIT is $750,000, Which plan will result in

the highest EPS? Show your work

.

(4 marks)

c)

Calculate the breakeven EBIT for each plan

.

(

2

marks)

d)

Calculate the indifference EBIT (4 marks)

e)

Calculate EPS for each plan at this level of EBIT

(2 marks)

Problem #

5

(

1

9

marks)

Rene's Renovations

Inc.

is planning a major expansion program requiring $5,000,000 in financing.

Option #1: Rene's

may sell bonds with an 8% coupon rate

,

or

Option #2: Rene's may

sell 200,000 shares of common stock to get the needed funds.

After the expansion there is a 30% probability of EBIT (Earnings Before Interest and Taxes) being $2 million, a

50% probability of

EBIT

being $3 million and a 20% probability of

EBIT

being $4

million. The following data was

taken from the firm's pre

-

expansion income statement:

Interest expense

$100,000

Tax Rate

40%

Common shares outstanding

300,000

a)

Calculate the EPS based on the expected EBIT under each alternative.

(5 marks)

b)

Which plan

would you chose at this level of EBIT?

(1 mark)

c)

Which option

will have the higher DF

L (Degree of Financial Leverage

-

no calculation required)

?

(1

mark)

d)

What level of EBIT would yield the same EPS for the stock and debt alternatives?

(5 marks)

e)

What EPS

corresponds to this level of EBIT?

(2 marks)

f)

Instead of

Option #2 (issuing 200,000 common shares),

if

the company decided they should issue only

100,000 common shares at $25 each and finance the remainder of the project with 3% preferred

shares, what would the indifference point be?

(5 marks)

Problem #

6

(5 marks)

Florence Flooring Limited

is

considering

two different financing plans.

1.

Under plan I the interest

would be

8% on $100,000 face value bonds.

2.

Under plan II the interest

would be

$

10,125 with

1,

400

shares of common stock outstanding

.

If the indifference point is $2

5

,000 and the tax rate is 30%,

how many shares of common stock are outstanding

for plan I?