A firm is analyzing two different capital structures for financing a new project that will cost RM100,000. The two structures are described below:
Plan A: finance with 50% debt
Debt (bonds) RM50,000
Common equity RM50,000
Plan B: finance with 90% debt
Debt (bonds) RM90,000
Common equity RM10,000
New common stock can be sold for RM10 per share. The bonds can be issued with a 8% coupon rate. The firm's existing shares are given below:
Preferred stock:
(RM100 par value) RM 50,000
Common stock:
(RM2 par value) RM40,000
The firm's existing shares of preferred stock pay dividends of RM2.00 per share. The firm's corporate tax rate is 28%.
a) Calculate the indifference level of EBIT between the two plans.
b) Proves your answer to show that the EPS will be the same regardless of the plan chosen at the EBIT level found in part (a).
c) Which financing plan would you expect to cause the greatest change in EPS relative to a change in EBIT? Why?
d) If EBIT is expected to be RM 30,000 , which plan will result in a higher EPS?
Show your answer using EBIT-EPS analysis chart.