Which form of financing should the firm use to obtain the $100 million? The alternatives are bonds, common stock and preferred stock.
1 a) Calculate the EPS under each alternative for 2008. Assume that the security is issued at the start of 2008. EPS = {(EBIT – Interest)(1- T) – Preferred Dividends (if any)} divided by the # of shares outstanding under that alternative. In this case, the common stock and preferred stock alternatives have no interest. b) Calculate the breakeven level of EBIT for i) Debt versus Common Stock and ii) Preferred Stock versus Common Stock. Why don’t we need to calculate the breakeven level of EBIT for Debt versus Preferred Stock?
2. Calculate the ratio of Total Debt to Total Assets under each form of financing, before the security is issued and after the security is issued. Add the issue size to assets, and to either debt or equity in order to calculate this ratio after the issue.
3. Calculate the Times-Interest-Earned (TIE) and the Debt Service Coverage (DSC) ratios under each form of financing for 2008. TIE = EBIT/Interest. DSC = EBIT/[Interest + Debt Principal Repayment/(1 – T)], where T is the firm’s tax rate. The principal repayment is the annual principal repayment obligation of the debt (sometimes called the sinking fund). Calculate the following for each alternative: EBIT/[Interest + (Principal + Dividends)/(1 – T)] Where Dividends = preferred stock dividends + common stock dividends under each alternative.