A corporation has $5,000,000 in 10 percent bonds and $3,000,000 in 12 percent preferred stockoutstanding. The firm's financial break-even (assuming a 40 percent tax rate) is __________.
A) $1,100,000
B) $1,400,000
C) $716,000
D) $860,000

Question

Quizplus · Accepted Answer

The financial break-even point is the level of EBIT where the firm covers its fixed financial costs (interest and preferred dividends). Interest on bonds is $500,000 (10% of $5,000,000), and preferred dividends are $360,000 (12% of $3,000,000). Total financial costs are $860,000. Since interest is tax-deductible, the after-tax cost is $500,000 * (1 - 0.40) = $300,000. Adding preferred dividends, the break-even EBIT is $300,000 + $360,000 = $660,000.

A Corporation Has $5,000,000 in 10 Percent Bonds and $3,000,000