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Sand Key Development Company has a capital structure consisting of $20 million of 10% debt and $30 million of common equity.

Sand Key Development Company has a capital structure consisting of $20 million of 10% debt and $30 million of common equity. The firm has 500,000 shares of common stock outstanding. Sand Key is planning a major expansion and will need to raise $15 million. The firm must decide whether to finance the expansion with debt or equity. If equity financing is selected, common stock will be sold at $75 per share. If debt financing is chosen, 6% coupon bonds will be sold. The firm's marginal tax rate is 34%. Determine the level of operating income at which Sand Key would be indifferent between debt financing and equity financing.

$5,675,000

$6,725,000

$4.625,000

$6,200,000

$5,150,000

Solutions

Expert Solution

EPS if the firm chooses the equity option:

 

EPS if the firm chooses the Debt option

 

Total number of share will be 500000

 

EPS indifference equation:

 

((EBIT - 2000000) * 0.66)/ 700000 = ((EBIT - 290000) * 0.66)/ 500000

 

                           5 EBIT - 10000000 = 7 EBIT - 20300000

 

 

2EBIT = 10300000

 

EBIT = 10300000/2

         = 5150000

 

Ans The EBIT is indifferent at = 5150000.

Ans The EBIT is indifferent at = 5150000.

Junaid answered 2 years ago
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