The MAX Corporation is planning a $4,000,000 expansion this year. The expansion can be financed by issuing
either common stock or bonds.
The new common stock can be sold for $60 per share. The bonds can be issued
with a 12 percent coupon rate. The firm's existing shares of preferred stock pay dividends of $2.00 per share.
The company's corporate income tax rate is 46 percent. The company's balance sheet prior to expansion is as
follows:
MAX Corporation
Current Assets $2,000,000
Fixed Assets 8,000,000
Total Assets $10,000,000
Current Liabilities $1,500,000
Bonds:
(8%, $1,000 par value) 1,000,000
(10%, $1,000 par value) 4,000,000
Preferred Stock:
($100 par value) $500,000
Common Stock:
($2 par value) 700,000
Retained Earnings 2,300,000
Total Liabilities and Equity $10,000,000
a. Calculate the indifference level of EBIT between the two plans.
b. If EBIT is expected to be $3 million, which plan will result in higher EPS?
a.
EPS: Stock Plan EPS: Bond Plan
(EBIT-$48,000)(1 - .46)-10,000
(350,000 + 66,667)
(EBIT - $960,000)(1 - .
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