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14. The Albany Company has a present capital structure consisting of common stock ($200 million, 10...

14. The Albany Company has a present capital structure consisting of common stock ($200 million, 10 million shares) and debt ($150 million, 8% coupon rate). The company is planning a major expansion and is undecided between two financing plans.

Plan A: Equity financing. Under this plan, an additional 2.5 million shares of common stock will be sold at $15 per share.

Plan B: Debt financing. Under this plan, $37.5 million of 10% long-term debt will be sold. At what level of operating income (EBIT) will the firm be indifferent between the two plans? Assume a 21% marginal tax rate.

a) $6.75 million d) $30.75 million

Use breakeven EBIT formula

Solutions

Expert Solution

Plan A Plan B
Interest expense 150*8%= 12   (current debt outstanding) 12 (current debt) + (37.5*10%=3.75 )new Debt = 15.75
Number of shares outstanding 10+2.5=12.50 M shares 10 M shares

At breakeven ,Earning per share under both plans are equal .

Earning per share =Earning available to common stockholders /number of shares

Plan A Plan B
EBIT EBIT EBIT
less Interest 12 15.75
EBT EBIT-12 EBIT-15.75
less:Tax expense

.21[EBIT-12]

.21EBIT-2.52

.21[EBIT-15.75]

.21EBIT- 3.3075
EAT/Net income

[EBIT-12]-[.21EBIT-2.52]

EBIT-12-.21EBIT +2.52

.79EBIT - 9.48

[EBIT-15.75]-[.21EBIT-3.3075]

EBIT-15.75-.21EBIT+3.3075

.79EBIT- 12.4425
Number of shares outstanding 12.5 10

[.79EBIT - 9.48]/12.5 = [.79EBIT-12.4425]/10

.79EBIT -9.48 = 12.5[.79EBIT - 12.4425]/10

.79EBIT -9.48= 1.25[.79EBIT-12.4425]

.79EBIT -9.48 = .9875EBIT-15.553125

.9875 EBIT -.79 EBIT = 15.553125-9.48

.1975EBIT = 6.073125

EBIT = 6.073125 /.1975

          = 30.75 MILLION

Breakeven point EBIT = 30.75 million

jeff jeffy answered 5 months ago
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