Question: David Ding Baseball Bat Company currently has $3 million in debt outstanding, bearing an interest rate of 12 percent. It wishes to finance a $4 million expansion program and is considering three alternatives: additional debt at 14 percent interest (option 1), preferred stock with a 12 percent dividend (option 2), and the sale of common stock at $16 per share (option 3). The company currently has 800,000 shares of common stock outstanding and
is in a 40 percent tax bracket.
a. If earnings before interest and taxes are currently $1.5 million, what would be earnings per share for the three alternatives, assuming no immediate increase in operating profit?
b. Develop a break-even, or indifference, chart for these alternatives. What are the approximate indifference points? To check one of these points, mathematically determine the indifference point between the debt plan and the common stock plan. What are the horizontal axis intercepts?
c. Compute the degree of financial leverage (DFL) for each alternative at the expected EBIT level of $1.5 million