Your company is evaluating alternative plans to finance an expansion of its business as detailed below

Your company is considering the best way to finance its new operating division which requires finance of

$10m. Plan A involves all equity. Two million new shares will be issued at $5 each. Plan B involves the

use of financial leverage. Five million dollars will be raised by selling bonds with a coupon interest rate of

10% p.a. Under this plan, the remaining $5m would be raised from issuing shares at $5 each. The use of

financial leverage is considered to be a permanent part of the firms capitalisation so no maturity date is

needed for the analysis. The company pays tax at the rate of 36% and currently has $1m debt on issue with

a coupon interest rate of 10% p.a., and 2m shares. The current financial statements of the firm show

earnings before interest and tax (EBIT) of $1,500,000 and earnings per share (EPS) of 41.6 cents. The new

project is expected to add $1,200,000 to earnings before interest and tax.

(do not use excel to calculate your answers)

a) Calculate the EBIT indifference point

b) For EBIT = $2,400,000 calculate the EPS for each plan and identify which plan the company should

prefer.