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American Presidential is currently financing its $250,000 million in assets with 10 million shares of common stock. American is thinking of replacing its all-equity capital structure with a new capital structure containing 10% preferred stock, 40% debt, and 50% equity. The preferred stock bears a 6% dividend rate and debt pays a coupon of 9%. Projected EBIT is $40 million and the corporate tax rate is 34%.
a. Calculate earnings per share under the current all-equity capital structure and under the alternative financing plan.
b. At what EBIT will American be indifferent between the two capital structure alternatives?
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