The Albany Corporation has a present capital structure consisting of common stock ($200 million, 10 million shares) and debt ($150 million, 8%). The company is planning a major expansion and is undecided between two financing plans. Plan A:
Equity financing. Under this plan, an additional 2.5 million shares of common stock will be sold at $15 each.
Plan B:
Debt financing. Under this plan, $37.5 million of 10% long-term debt will be sold.

What happens to the EBIT indifference point if the interest rate on the new debt decreases and the common stock price remains constant?
A) The indifference point increases.
B) The indifference point decreases.
C) The indifference point does not change.
D) Cannot be determined from the information provided

Question

The Albany Corporation has a present capital structure consisting of common stock ($200 million, 10 million shares) and debt ($150 million, 8%). The company is planning a major expansion and is undecided between two financing plans. Plan A:
Equity financing. Under this plan, an additional 2.5 million shares of common stock will be sold at $15 each.
Plan B:
Debt financing. Under this plan, $37.5 million of 10% long-term debt will be sold.
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What happens to the EBIT indifference point if the interest rate on the new debt decreases and the common stock price remains constant?
A) The indifference point increases.
B) The indifference point decreases.
C) The indifference point does not change.
D) Cannot be determined from the information provided

Quizplus · Accepted Answer

The EBIT indifference point is the level of earnings before interest and taxes at which the choice between the two financing plans produces the same EPS. As the interest rate on the new debt decreases, the interest expenses decrease, resulting in higher EPS at each level of EBIT. Therefore, the EBIT indifference point decreases, making Plan B more attractive than Plan A. Therefore, Plan B is the best choice.

The Albany Corporation Has a Present Capital Structure Consisting of Common