Jimmy Shoes Inc. has 10,000 shares outstanding with a stock price of $40 per share. The current weighted average cost of capital is 7%. It also carries long-term debt of $200,000 at an interest rate of 7% p.a. One of the agenda items in its AGM is to switch to a D/E of 1. Based on this information, answer the following questions:

a) What will be the number of outstanding shares for Jimmy Shoes Inc. if it switches to a D/E ratio of 1? (Hint: Current Debt = $200,000, current equity = 10,000 shares x $40 = $400,000, current D/E = 2/4 = 0.5/1. If the firm seeks to increase its D/E to 1, it can think of borrowing more)

(3.5 marks)

b) What is the level of EBIT at which shareholders will be indifferent between the two capital structures, the one with a D/E = 0.5/1 and the other with a D/E of 1?