Question

Tortuga, Inc. is looking to raise $750,000 for new equipment to enhance the efficiency of its operations. The firm currently is capitalized with 200,000 shares of equity at a market price of $12 per share and also has $1,000,000 of debt with an interest rate of 7%. The company believes that with the new capital they could achieve an EBIT of $250,000. Assume new equity could be issued at current market price and that new debt would still carry a 7% coupon. The company has a 25% marginal tax rate.

		Equity	Debt
	EBIT	$250,000	$250,000
-	interest
	EBT
-	tax
	Net income
÷	shares
	EPS

1. Calculate the EBIT which would make Tortuga indifferent between issuing Equity or Debt on the basis of EPS and graph your chart in the space below with clearly labeled axis and amounts.

Answer 1

Solution
	We have option for raise fund by either Debt or Equity
	Let us Assume
	plan A as Fund Raised by Equity
	plan B as Fund Raised by Debt
	Amount of fund to be Raise is $750000
	NO. of share to be issue should be
		=750000/12
		62500
	NO. of share is 62500
	Total no. of share	262500
	Now ,
					Fig in ($)
	Calculation of EPS	Plan A	Plan B
	EBIT	250000	250000
Less	Interest	70000	70000
	Debt is $1000000
	=1000000*7%
	New Debt for Plan B
	=750000*7%		52500
	EBT	180000	127500
Less	TAX	45000
For plan A	=180000*25%
For plan B	=127500*25%		31875
	Net Income for Shareholder	135000
EPS=Net income /no. of share		0.514286
For plan A	=135000/262500
For plan B	=31875/200000		0.159375
	Advice is Plan A is better option for raising Fund AS eps is higher in plan A