Question

Create an Excel spreadsheet to organize your answers to the following problem, and submit your Excel file as an attachment by clicking on the appropriate button on this page.

A company with EBIT of $6,000,000 is considering two financing alternatives. The first alternative would have $25 million of bonds at 8% interest and 1,000,000 common shares outstanding, whereas the second would have $47.5 million of bonds at 8% interest and only 750,000 shares outstanding. The company is in the 35% tax bracket.

Part 1: Construct the bottom half of the income statement (including EPS) for each financing alternative when EBIT is at $6,000,000.

Part 2: Construct the bottom half of the income statement (including EPS) for each alternative if EBIT increases by 20%.

Part 3: Construct the bottom half of the income statement (including EPS) for each alternative if EBIT decreases by 20%.

Part 4: What is the EBIT/EPS indifference point for this firm?

Part 5: Comment on the results of your calculations above. What principle does this exercise demonstrate?

Answer 1