[ckust08]

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?

[manik chand dey]

40% debt asset ratio Vs all equity

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

[manik chand dey]

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

[manik chand dey]

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.