An EBIT-EPS indifference chart for Rail Shipping Inc. indicates a breakeven point occurs at EBIT of $100 million. If the company issues shares to finance an expansion, EBIT will be $20 million below the indifference point. If bonds are issued, EBIt will be $30 million below the indifference point. What is the most appropriate conclusion to draw from this data?

Question

Quizplus · Accepted Answer

To determine the breakeven point with the issuance of shares or bonds, we need to calculate the new EBIT level.

For the issuance of shares, the new EBIT level would be $100 million - $20 million = $80 million. 
For the issuance of bonds, the new EBIT level would be $100 million - $30 million = $70 million.

Now we need to calculate the percentage increase in EBIT required to make each alternative a better option than the other.

For the issuance of shares:

(Required increase in EBIT / initial EBIT) x 100% = (100 - 80 / 100) x 100% = 20%

For the issuance of bonds:

(Required increase in EBIT / initial EBIT) x 100% = (100 - 70 / 100) x 100% = 30%

Therefore, to make bonds a better option than shares, EBIT would have to increase by 30%, which is the answer choice D.

An EBIT-EPS Indifference Chart for Rail Shipping Inc