Management of Total S.E.A. Inc. is considering two alternative financing plans. The detailed information is given in the table below.

The par value of common stock is $10, preferred stock has $100 par value and pays 15% dividend, and long-term debt is presented by 10-year bonds of $1,000 par value and a fixed annual coupon rate of 8%. The corporate income tax rate is 30%.

What is the breakeven EBIT? Which option is better if the forecasted EBIT is $2,200,000?

Guide to answer Illustration 2:

The first step of EBIT-EPS analysis is to find the indifference point. Thus, we have to calculate interest expense and preferred dividends for each financing plan. Plan A: Cost and number of common stocks issued

IA = $5,000,000 8% = $400,000 PDA = $3,000,000 15% = $450,000 SA = $15,000,000 10 = 1,500,000

Plan B: Cost and number of common stocks issued IB = $13,000,000 8% = 1,040,000 PDB = $2,000,000 15% = $300,000 SB = $8,000,000 10 = 800,000