National Value Foods Company (NVFC) is considering opening a new wholly owned subsidiary in Booneville. To finance this investment, NVFC is considering two financing plans: (1) sell 600,000 shares of common stock at $20 each or (2) sell 200,000 shares of common stock at $20 each and $8 million of 10 percent long-term debt.
a. If NVFC has a marginal tax rate of 40 percent, what is the EBIT-EPS indifference point for this investment?
b. NVFC's expected level of EBIT from this division is $1.0 million with a standard deviation of $400,000. If the firm uses the second financing plan, what is the chance of having unfavorable financial leverage?