Ipsy Dipsy Preschools, Inc.has a capital structure that consists of 60% common equity (2.0 million shares), 30% long-term debt ($10 million with 12% coupon), and 10% preferred stock ($50 par value with $4.75 dividend).The company is planning a major plant expansion and is undecided between the following two financing plans:
1) Equity financing: Sale of 400,000 shares of common at $10 each.
2) Debt financing: Sale of$4 million of 12.5 percent long-term bonds.
Calculate the EBIT-EPS indifference point.Assume the marginal tax rate is 40%.
A)$4.253 million
B)$3.051 million
C)$3.654 million
D)$4.728 million

Question

Quizplus · Accepted Answer

Solution: Total current capitalization= $10,000,000 debt/0.3 = $33,333,333
Preferred stock= 0.10 × $33,333,333 = $3,333,333
Preferred shares = $3,333,333/$50 = 66,667
Preferred dividends = 66,667 × $4.75 = $316,668.25
 $$\frac { ( \mathrm { EBIT } - 1.7 ) ( 0.6 ) - 0.317 } { 2 } = \frac { ( \mathrm { EBIT } - 1.2 ) ( 0.6 ) - 0.317 } { 2.4 }$$ 
EBIT* = $4,727,779 or $4.728 million