A company with EBIT of $6,000,000 is considering two financing alternatives. The first alternative would have interest expense of $2,000,000 and 1,000,000 common shares outstanding, whereas the second would have interest expense of $3,800,000 but only 750,000 shares outstanding. The company is in the 35% tax bracket.
Part 1: Construct the bottom half of the income statement (including EPS) for each financing alternative when EBIT is at $6,000,000.
Part 2: Construct the bottom half of the income statement (including EPS) for each alternative if EBIT increases by 20%.
Part 3: Construct the bottom half of the income statement (including EPS) for each alternative if EBIT decreases by 20%.
Part 4: What is the EBIT/EPS indifference point for this firm?
Part 5: Comment on the results of your calculations above. What principle does this exercise demonstrate?