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Hi-Grade Regulator Company currently has 100,000 shares of common stock outstanding with a market price of...

Hi-Grade Regulator Company currently has 100,000 shares of common stock outstanding with a market price of $60 per share. It also has $2 million in 6 percent bonds. The company is considering a $3 million expansion program that it can finance with all common stock at $60 a share (option 1), straight bonds at 8 percent interest (option 2), preferred stock at 7 percent (option 3), and half common stock at $60 per share and half 8 percent bonds (option 4).
a. For an expected EBIT level of $1 million after the expansion program, calculate the earnings per share for each of the alternative methods of financing. Assume a tax rate of 50 percent.
b. Construct an EBIT-EPS chart. Calculate the indifference points between alternatives.
c. What is your interpretation of them?

Solutions

Expert Solution

Calculating EPS for each of the option:

Stimulating the EPS levels at different EBIT levels in excel:

The indifference curve is plotted as:

Notes:

Option 2 - servicing the expansion through debt always gives higher EPS a EBIT levels above $1 mil than the other options.

Option 4 - servicing the exapansion with debt + equity offers the next highest EPS when EBIT levels are between $1 mil to $1.75 mil

jeff jeffy answered 2 years ago
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