DMC currently has 100,000 shares of common stock outstanding with a market price of $50 per share. It also has $2 million in 7% bonds currently selling at par. The company is considering a $4 million expansion program that it can finance either (I) all common stock at $50 per share, or (II) all bonds at 9%. The company estimates that if the expansion is undertaken, it can attain, in the near future, $1 million EBIT. a. The company’s tax rate is 40%. Calculate EPS for each plan. b. Draw the EBIT-EPS graph. c. What is the break-even or indifference point between the two alternatives?

DMC currently has 100,000 shares of common stock outstanding with a market price of $50 per share. It also has $2 million in 7% bonds currently selling at par. The company is considering a $4 million expansion program that it can finance either (I) all common stock at $50 per share, or (II) all bonds at 9%. The company estimates that if the expansion is undertaken, it can attain, in the near future, $1 million EBIT. a. The company’s tax rate is 40%. Calculate EPS for each plan. b. Draw the EBIT-EPS graph. c. What is the break-even or indifference point between the two alternatives?

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter14: Capital Structure Management In Practice

Section: Chapter Questions

Problem 20P

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DMC currently has 100,000 shares of common stock outstanding with a market price of $50 per share. It also has $2 million in 7% bonds currently selling at par. The company is considering a $4 million expansion program that it can finance either (I) all common stock at $50 per share, or (II) all bonds at 9%. The company estimates that if the expansion is undertaken, it can attain, in the near future, $1 million EBIT. Which plan is riskier, I or II? Why?
DMC currently has 100,000 shares of common stock outstanding with a market price of $50 per share. It also has $2 million in 7% bonds currently selling at par. The company is considering a $4 million expansion program that it can finance either (I) all common stock at $50 per share, or (II) all bonds at 9%. The company estimates that if the expansion is undertaken, it can attain, in the near future, $1 million EBIT. Draw the EBIT-EPS graph.
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Hastings Corporation is interested in acquiring Vandell Corporation. Vandell has 1.5 million shares outstanding and a target capital structure consisting of 30% debt; its beta is 1.60 (given its target capital structure). Vandell has $8.57 million in debt that trades at par and pays a 7.4% interest rate. Vandell’s free cash flow (FCF0) is $1 million per year and is expected to grow at a constant rate of 5% a year. Vandell pays a 25% combined federal-plus-state tax rate, the same rate paid by Hastings. The risk-free rate of interest is 4%, and the market risk premium is 6%. Hasting’s first step is to estimate the current intrinsic value of Vandell.
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