PQR Company presently has $3 million in debt outstanding bearing an interest rate of 12%. It wishes to finance a $4 million expansion program and is considering three alternatives: additional debt at 14% interest, preferred stock with a 12% dividend, and the sale of common stock at $16 per share. The company presently has 800,000 shares of common stock outstanding and is in a 40% tax bracket.

Required:

a) Do an EBIT-EPS analysis to determine the effects of the financing alternatives on PQR's performance (assuming that EBIT is presently $1.5 million and there is no immediate increase in profitability).

b) Compute the indifference points between debt and common stock and between preferred and common stock.

c) Compute the degrees of financial leverage (DFL) for the debt and common stock alternative (you may use $1.5 million as EBIT or any number you think appropriate). Which alternative do you prefer assuming an EBIT of $1.5 million?