Hey you, I was hoping someone could help me with this problem...

Chitown is a new firm seeking to finance $20 million in assets. It is considering a 40 percent deb/ asset ratio vs. an all equity capital structure. New debt will carry interest charges of 12 percent and new shares can be sold for $20 per share.

A) What is the number of shares under each plan?

B) Assuming a 40-percent tax rate, find the level of EBIT at which both plans will have the same EPS?

40% debt asset ratio Vs all equity

A)No of shares 600,000 100,00,00

B) In order to calculate the level of EBIT at which both plans will have same EPS, we need to equalise the EPS under both the plans.

Let say x = the level of EBIT

Debt/Equity Plan All Equity Plan

Let say x= the level of EBIT

Debt Equity Plan All equity Plan
EPS (x-960000)(1-0.40)/600000 x(1-0.40)/1000000

Now equating this EPS under both the plans we will be getting x equals to around$10,21,276.
This is the level of EBIT where financial breakeven point is achieved, otherwise called as indifference point.