Emco Products has a present capital structure consisting only of common stock (10 million shares). The company is planning a major expansion. At this time, the company is undecided between the following two financing plans (assume a 40 percent marginal tax rate):
¦ Plan 1: Equity financing. Under this plan, an additional 5 million shares of common stock will be sold at $10 each.
¦ Plan 2: Debt financing. Under this plan, $50 million of 10 percent long-term debt will be sold.
One piece of information the company desires for its decision analysis is an EBIT-EPS analysis.
a. Calculate the EBIT-EPS indifference point.
b. Graphically determine the EBIT-EPS indifference point. Hint: Use EBIT = $10 million and $25 million.
c. What happens to the indifference point if the interest rate on debt increases and the common stock sales price remains constant?
d. What happens to the indifference point if the interest rate on debt remains constant and the common stock sales price increases?