Case scenario: Morton Industries is considering opening a new subsidiary in Boston, to be operated as a separate company. The company's financial analysts expect the new facility's average EBIT level to be $6 million per year. At this time, the company is considering the following two financing plans (use a 40 percent marginal tax rate in your analysis):
Plan 1 (Equity Financing). Under this plan, $2 million common shares will be sold at $10 each.
Plan 2 (Debt equity financing). Under this plan, $10 million of 12 percent long-term debt and 1 million common shares at $10 each will be sold.
a. Calculate the EBIT-EPS indifference point.
b. Calculate the expected EPS for both financing plans.
c. What factors should the company consider in deciding which financing plan to adopt?
d. Which plan do you recommend the company adopt?
e. Suppose Morton adopts Plan 2, and the Boston facility initially operates at an annual EBIT level of $6 million. What is the times interest earned ratio?