Alace is an all-equity firm with 10 million shares outstanding and is evaluating two alternative financing plans. With the first plan, Alace will sell 1 million shares of common stock at $15 each. Under the second plan, the firm would sell $15 million of 12% long-term debt. If Alace has a marginal tax rate of 35%, what is the EBIT-EPS indifference point?

Question

Quizplus · Accepted Answer

The EBIT-EPS indifference point is where the earnings per share (EPS) are the same under both financing plans. For the first plan, the firm issues 1 million shares, making a total of 11 million shares. For the second plan, the firm incurs $1.8 million in after-tax interest (12% of $15 million, reduced by the 35% tax rate). Setting the EPS equations equal for both plans and solving for EBIT gives the indifference point of $19.8 million.

Alace Is an All-Equity Firm with 10 Million Shares Outstanding