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Husky Dudz Inc. is a high end producer of dog clothes for the pets of celebrities. The firm is considering the opening of a new subsidiary in Los Angeles so the firm will be closer to its market. The subsidiary will operate as a separate company in the United States and the firm has a tax rate of 40 percent. The company's financial experts have estimated that EBIT will average $6,000,000 per year. The firm is considering the following financial plans:
Plan A: Issue 2 million shares at $10.00 (net) each.
Plan B: Issue $10 million in 8 percent coupon bonds and finance the balance with equity.
a. Calculate the EBIT/EPS indifference point.
b. How do you know your calculations are correct?
c. What is the significance of this EBIT/EPS indifference point?
d. Which financing plan should the company use?
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