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 is the EBIT-EPS indifference point? Assume a 40 percent marginal tax rate.
A) $33.9 million
B) $30.75 million
C) $37.0 million
D) $12.9 million

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.
?
What is the EBIT-EPS indifference point? Assume a 40 percent marginal tax rate.
A) $33.9 million
B) $30.75 million
C) $37.0 million
D) $12.9 million

Quizplus · Accepted Answer

To find the EBIT-EPS indifference point, we need to set the earnings per share (EPS) for Plan A equal to the EPS for Plan B and solve for the EBIT.

EPS (Plan A) = EPS (Plan B)

[EBIT - (1 - T)(0.8*$150 million)] / (10 million + 2.5 million) = [EBIT - (1 - T)*$37.5 million] / 10 million

Where:
T = Marginal tax rate = 40%
Debt cost = 8%
Thus:
EBIT = $30.75 million

Therefore, the EBIT-EPS indifference point is $30.75 million. Since Plan B has a lower EBIT at which to break even, it is the better choice.

The Albany Corporation Has a Present Capital Structure Consisting of Common