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Question - Geoff's Golf Clubs is considering purchasing a small firm in the same line of business. The purchase would be financed by the sale of common stock or a bond issue. The financial manager needs to evaluate how the two alternative financing plans will affect the earnings potential of the firm. Total financing required is $4.5 million. The firm currently has $20 million of 12% bonds and 600,000 common shares outstanding. The firm can arrange financing of the $4.5 million through a 14% bond issue or the sale of 100,000 shares of common stock. The firm has a 40 percent tax rate.
Required -
a) If EBIT is expected to be $5 million, which plan will result in higher EPS?
b) If EBIT is expected to be $8 million, which plan will result in higher EPS?
c) Calculate the indifference level of EBIT between the two plans.
Hubbard argues that the Fed can control the Fed funds rate, but the interest rate that is important for the economy is a longer-term real rate of interest. How much control does the Fed have over this longer real rate?
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