Assignment: Firm X with a 40% tax rate is comparing two financing plans. Plan A involves 2,000 shares of common stock and $20,000 of debt. Plan B consists of 2,500 shares of common stock and $10,000 of debt. The annual interest rate is 5%. Presently, this company is all-equity financed and has 3,000 shares outstanding.
Question 1: What is the indifferent point of EBIT between these two plans?
A) $8,000
B) $7,000
C) $6,000
D) $5,000
E) $4,000
Question 2: At the indifference point of EBIT calculated in Question (above), what will be the corresponding earnings per share (EPS)?
A) $0.6
B) $0.8
C) $1.0
D) $1.2
E) $1.4
Question 3: What is the fixed financing cost (i.e. interest payment on debt) that the company has to face under Plan A?
A) $500
B) $750
C) $1,000
D) $1,250
E) Undetermined
Question 4: If the future EBIT is estimated to be $8,000, which plan will this company prefer?
A) Plan A because of its higher EPS
B) Plan B because of its higher EPS
C) Neither plan because of the high leverage
D) Both plans because of their equal EPS